Mauricio Villamizar Villegas, Banco de la República (The Central Bank of Colombia)
Tomas Williams, George Washington University
Abstract: In emerging markets, higher bond term premia are typically accompanied by higher currency premia. We attribute this relationship to the prominent role of global investors in local-currency bond markets and their limited use of currency hedging. Using transaction-level data from Colombia’s bond and foreign exchange markets, we show that foreign investors’ bond trades are systematically accompanied by simultaneous transactions in the spot exchange market, but not in the forward exchange market. We incorporate these correlated flows into a portfolio-balance model that also accounts for short-term interest rate risk. The model helps explain cross-country differences in the comovement of bond yields and exchange rates, the observed patterns of positions and returns in bond and foreign exchange markets, and the effects of quantitative easing and foreign exchange interventions.
Discussant: Julie Fu, Washington University-St. Louis
Michele Dathan, Federal Reserve Board of Governors
Michael Young, University of Missouri
Qifei Zhu, National University of Singapore
Abstract: Misspecified benchmarks are widespread among active bond mutual funds, driven in part by the industry’s heavy dependence on the Bloomberg U.S. Aggregate Index. Active funds outperform their self-declared benchmarks by 3% over a 36-month horizon. However, this outperformance is fully explained by their choice of benchmarks, which on average have lower systematic risk than actual fund portfolios. When evaluated against more appropriate benchmarks identified from return correlations, bond funds underperform. Benchmark-adjusted returns strongly predict future flows, giving
managers incentives to misbenchmark. Benchmark changes are infrequent, but on average funds switch to easier-to-beat benchmarks following periods of lower flows, and subsequently experience a temporary increase in flows. We posit that bond fund misbenchmarking is likely to persist due to regulatory changes that cement over-reliance on aggregate indexes, which do not represent the entire fixed income market.
Discussant: Kevin Mullally, University of Central Florida
Abstract: We examine cross trading by mutual funds in corporate bonds. We find that cross trading is relatively common in the 2009 to 2022 period, with substantial variation across fund families and greater activity for illiquid and hard-to-obtain bonds. Cross trading is particularly elevated around maturity cutoffs, credit rating changes, and periods of extreme fund flows, suggesting that it can be beneficial in times of pressure. High-fee funds tend to cross with lower-fee funds, but we find no evidence that crossing transfers performance from low- to high-value funds. We document large transaction cost savings, although these savings have diminished following a regulatory change that significantly limits cross trading.
Discussant: Russell Wermers, University of Maryland
