The Sector Liquidity Timing Ability of Bond Mutual Funds

We investigate whether bond mutual fund managers exhibit market liquidity timing skills in the US corporate bond market. At the portfolio level, we find weak evidence that bond funds adjust their overall market exposure in anticipation of changes in corporate bond market liquidity. We then investigate bond mutual funds' sector liquidity timing ability for investment grade, high-yield, and mortgage-back security (MBS) sectors. That is, whether bond fund managers adjust fund exposures to specific bond sectors. We find strong evidence that fund managers demonstrate high-yield sector liquidity timing skills by successfully overweighting high-yield bonds as corporate bond market liquidity increases. At individual fund level analysis, we find that top-ranked bond funds show market liquidity timing skills with respect to the overall market, investment grade, high yield, and MBS sectors. Our bootstrap analysis confirms that these liquidity timing skills of bond fund managers are not purely due to luck. In the persistence test, we find evidence of persistence in sector liquidity timing skills over time, especially for high-yield sector timing. These sector liquidity timing strategies also predict future fund performance to some extent.