Bond Mutual Fund and Exchange-Traded Fund Flows in Stressed Markets: Empirical Evidence on the Destabilization Hypothesis

The proposed mechanism for what we term the destabilization hypothesis is that an exogenous shock triggers large redemptions by fund investors, requiring fund managers to sell securities to raise cash, leading to further drops in security prices and increased systemic risk. Although a large body of literature finds little evidence of fund-driven fire sales in bond markets, the destabilization hypothesis has seen renewed interest among academics and policymakers in the context of bond funds. We examine the impact of shocks on U.S. bond fund flows by sub-asset class and by type of investment vehicle. The time-series analysis we conduct shows that a risk-off shock to markets does not necessarily result in large bond fund outflows. Accordingly, we conclude that there is little evidence that bond funds are a source of systemic risk, particularly bond ETFs. We also find no evidence of a non-linear response of flows to large shocks. The views expressed here are ours alone. This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. We thank Ross Pastman and Tom Fickinger for their research assistance.