Significant fluctuations of net flows in and out of corporate bond funds during times of economic uncertainty and shifts in monetary policy can present critical challenges for fund managers (Figure 1) tasked with a) ensuring their funds are sufficiently liquid to meet investor redemptions, and b) deploying investor cash in sound investments. The recently launched Bloomberg Credit futures provide effective solutions to both these challenges.
Taxable bond mutual fund recent net flows1
Complicating a fund manager’s task is the fact that corporate bond mutual funds face unique liquidity risks relative to other major asset classes. Since many corporate bonds trade on an infrequent basis (Figure 2), liquidity in these markets can have a significant impact on bond prices. The daily redemption and subscription policies of most funds only contribute to this dynamic.
Selected asset class average daily volume for 20232
Two general scenarios are easy to imagine:
In a downward market, investors rush to redeem shares, forcing fund managers to sell bonds into an illiquid and falling market for significantly reduced prices.
In an upward market, investor subscriptions flow into the fund while bond prices are high, increasing demand for bonds in an already expensive market. This forces fund managers to either find increasingly limited buying opportunities to deploy the influx of cash or hold the cash on the fund’s books, adding to the “cash drag” of the fund’s performance.
Corporate bond fund managers are acutely aware of these potential scenarios and implement an array of strategies to manage fund liquidity (note that these are often implemented alongside or in conjunction with regulatory guidance). Figure 3 provides an overview of common strategies used to manage fund liquidity, as well as the potential implications of using them.
Figure 3: Selected fund cash management strategies and potential implications
|
Fund cash management strategy |
Potential strategy implication |
|---|---|
|
Redemption provisions (redeem in-kind, gated or halted redemptions) |
May make investors who are used to daily liquidity hesitant to invest |
|
Maintaining a cash liquidity sleeve as a certain percentage of fund net assets |
May contribute to "cash drag" of the fund, lowering performance |
|
Ceiling on illiquid security holdings / floor on liquid security holdings |
May limit performance of the fund |
|
Limits on the use of leverage |
May limit performance of the fund |
|
Derivatives (Index CDS) |
May create tracking error given basis between these instruments and the performance benchmark – however, Bloomberg Credit futures now offers futures on broad, representative benchmarks |
|
Derivatives (Listed futures) |
Listed futures are margin efficient, but available listed futures were typically interest rate focused - however, Bloomberg Credit futures now offers futures on broad, representative benchmarks |
With the introduction of Bloomberg Credit futures, fund managers can now replicate an entire basket of investment grade corporate bonds, high yield corporate bonds, or the spread-only portion of an investment grade bond index. The primary benefit of a futures position that closely tracks a corporate bond index is simple: Futures’ inherent leverage and representative underlying indices allow them to closely replicate a cash bond position with very little upfront capital:
Bloomberg Credit futures are based on indices that are representative of their underlying markets. Bloomberg bond indices are comprised of a robust and wide group of constituents, priced via Bloomberg Valuation Services (BVAL), and are widely used by a variety of bond market participants.
Leverage, in the form of initial margin, is low. Only about 0.65% (DHB), 1.3% (IQB), and 1.5% (HYB) of the contract notional value needs to be posted as initial margin.[3]
Credit futures are efficient, especially for fund companies already using U.S. Treasury futures or Equity Index futures from CME Group. Margin offsets are offered between Credit futures and other correlated products. For instance, margin credits of 75% between IQB and 10-Year U.S. Treasury Note futures, 65% between HYB and E-mini S&P 500 futures, and 65% between IQB and E-mini S&P 500 futures are available at the Exchange.
Bloomberg Credit futures now offer fund managers the ability to manage their fund liquidity precisely and efficiently. Access more details on Credit futures.
|
PRODUCT CODE |
IQB |
HYB |
DHB |
|
UNDERLYING INDEX |
Bloomberg U.S. Corporate Investment Grade Duration Hedged Index |
||
|
CONTRACT UNIT |
30 x Index Points |
150 x Index Points |
500 x Index Points |
|
MINIMUM PRICE FLUCTUATION |
1/2 of 1 Index Points (0.50 = $15.00) |
1/10 of 1 Index Points (0.10 = $15.00) |
1/20 of 1 Index Points (0.05 = $25.00) |
|
FINAL SETTLEMENT MINIMUM TICK |
0.0001 |
||
|
PRICE QUOTATION |
Index Points |
||
|
LISTING SCHEDULE |
Nearest 3 March Quarterly Months |
||
References
- ICI “Long-Term Mutual Fund Net Flows” data. 2024 YTD is through July.
- SIFMA Research data
- See CME Clearing Notice 24-168 for additional margin details
All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.
