Debt derisking

Abstract

We examine how corporate bond fund managers manipulate portfolio risk in response to incentives. We find that liquidity risk concerns drive the allocation decisions of underperforming funds, whereas tournament incentives are of secondary importance. This leads laggard fund managers to trade off yield for liquidity, while holding the exposure to other sources of risk constant. The documented de-risking is stronger for managers with shorter tenure and is reinforced by a more concave flow-to-performance sensitivity and by periods of market stress. De-risking meaningfully reduces ex post liquidation costs. Flexible NAVs (swing pricing) may, however, reduce de-risking incentives and create moral hazard.