Mutual Fund Holdings of
Credit Default Swaps:
Liquidity Management and Risk Taking
Wei Jiang, Columbia Business School
and
Zhongyan Zhu, Chinese University of Hong Kong
For
2nd Annual Conference on the Regulation of Financial Markets
By CFP Smith School of Business and SEC
SEC Headquarters, Washington DC, May 1, 2015
1
Simple facts: mutual fund holdings of single name CDS
positions, 2007-2009
•
Overall, heavier CDS sell positions than buy ones
Period
#Positions
Amount ($1,000s)
2007Q1
2007Q2
2007Q3
2007Q4
2008Q1
2008Q2
2008Q3
2008Q4
2009Q1
2009Q2
2009Q3
2009Q4
2007-2009
3098
4468
5886
6509
7281
9329
7667
6305
4922
3732
3868
3430
66495
13,154,975
15,898,276
20,034,953
22,064,073
24,317,488
29,161,554
25,989,193
22,565,593
21,158,307
15,392,066
15,694,105
15,976,014
241,406,597
Sell Amount
($1,000s)
8,535,859
9,315,313
13,654,085
14,306,067
15,024,279
17,443,943
15,986,209
11,880,053
9,560,698
8,080,759
8,446,495
9,145,908
141,379,668
#Funds
152
203
208
214
219
228
210
197
189
170
173
168
284
2
Research question
• Why did mutual funds hold more short CDS positions?
– Oehmke and Zawadowski (2014a): Liquidity transformation of CDS
– Rajan (2006): Benchmark performance evaluation and risk taking
3
Data sample
• Mutual fund CDS holdings, manually collected
– Source: SEC N-Q, N-CSR, and N-CSRS
• 2007-2009 quarterly filings
– Filter on mutual funds: regular CDS usage
• 284 mutual funds, 60 trust series, 33 mutual fund families
– CDS on single name reference entities
• 445 reference entities
• 66,495 CDS positions
• $241.4 billion quarter end holdings, of which $141 billion sell positions
• Merged with CRSP mutual funds database
4
Stylized facts
• Large vs. small mutual funds
– PIMCO took dominant role
– Large mutual fund families, PIMCO ($4.1 billion) and next 9 ($2.1
billion), took on more sell positons than small, the rest 23 ($1.4
billion), mutual fund families
Mutual fund
families
All
PIMCO
Next 9
Rest 23
#Positions
66495
26943
23312
16240
Amount
($1,000s)
241,406,597
149,074,496
57,445,008
34,887,093
% of total
100%
62%
24%
14%
Sell Amount
($1,000s)
141,379,668
95,106,951
33,149,319
13,123,398
Buy Amount
($1,000s)
100,026,929
53,967,545
24,295,689
21,763,695
5
Stylized facts, cont’d
• Large vs. small CDS reference entities
–
–
–
–
Top 50 CDSs (defined by dollar amount) were heavily traded
Sell positions of top 50 CDSs were higher than buys
Rest 399 CDSs, buys were more than sells
Top 50 CDSs had higher CDS spreads than the rest 399 CDSs
CDS
reference
entity
Top 50
Next 50
Rest 345
Amount
($1,000s)
% of total
154,945,903
32,928,095
53,532,599
64%
14%
22%
Sell Amount Buy amount Avg spread
($1,000s)
($1,000s)
in 2007
114,762,631 40,183,271
7,885,987 25,042,108
18,731,050 34,801,549
0.0294
0.0144
0.0268
Avg spread
in 2008
0.1072
0.0339
0.0767
Avg spread
in 2009
0.1199
0.0205
0.0522
• Each position is classified as sell (59%), offsetting buy (2%),
hedging buy (21%), or speculative buy (17%)
6
Tests on liquidity management, fund level, 1/2
•
Propensity of CDS usage
– One standard deviation increase of flow volatility implies 2.5 percentage points increase
in sell probability (unconditional sell probability 4.6%)
– Multinomial logit, baseline outcome no-buy-no-sell
– Controls: Fund size, age, rank, Lipper dummy, and quarter dummy. S.e. clustering at fund
level
Logit
Dependent variable:
Flow volatility
Portfolio Turnover
# observations
% (Dep var =1)
Pseudo R squared
Logit, vs. no buy no sell
Both buy and
Buy no sell
Sell no buy
sell
(3)
(4)
(5)
Any sell
Any buy
(1)
(2)
12.51***
(2.442)
0.294***
(0.0552)
8.919***
(2.494)
0.279***
(0.0538)
3.055
(3.757)
0.123***
(0.0456)
12.44***
(2.786)
0.316***
(0.0615)
13.57***
(3.984)
0.168***
(0.0611)
19,137
5.22%
0.2390
19,454
4.87%
0.1968
16,000
1.64%
0.1133
18,565
3.68%
0.2418
15,291
2.06%
0.2380
7
Tests on liquidity management, fund level, 2/2
•
Intensity of CDS usage
– One standard deviation increase of flow volatility implies 1.61 percentage points
increase in sell intensity (unconditional selling intensity 0.13%)
– Controls: Fund size, age, rank, Lipper dummy, and quarter dummy. S.e. clustering at fund
level
Tobit
Dependent variable:
Flow volatility
Portfolio Turnover
# observations
Pseudo R squared
Gross sell intensity
(1)
Gross buy intensity
(2)
38.65***
(9.285)
0.913***
(0.171)
26.83***
(8.831)
1.093***
(0.207)
19,454
0.1427
19,454
0.1241
8
Tests on liquidity management, fund-CDS level, 1/2
•
Propensity of CDS usage
– Controls: fund size, age, performance rank; Lipper fund category dummy; quarter
dummy; heteroskedasticity standard errors clustering at fund level
Logit
Dependent variable
Any sell
(1)
Any buy
(2)
Any sell
(3)
Any buy
(4)
0.221
(0.221)
0.724***
(0.0556)
0.589***
(0.0417)
0.263
(0.252)
0.0770***
(0.0178)
0.137***
(0.0266)
14.00***
(3.389)
0.233***
(0.0559)
0.220
(0.224)
0.732***
(0.0555)
0.596***
(0.0431)
7.520**
(3.091)
0.328***
(0.0530)
0.268
(0.256)
0.0788***
(0.0182)
0.141***
(0.0275)
4,094,042
0.075%
0.1455
4,117,080
0.140%
0.1085
4,094,042
0.075%
0.2285
4,117,080
0.140%
0.2455
Flow volatility
Portfolio turnover
Bond turnover
# CDS contracts
Assets reference entity
# observations
% (Dep var =1)
Pseudo R squared
9
Tests on liquidity management, fund-CDS level, 1/2
•
Propensity of CDS usage
– Controls: fund size, age, performance rank; Lipper fund category dummy; quarter
dummy; heteroskedasticity standard errors clustering at fund level
Multinomial logit
Dependent variable:
Buy no sell
(5)
Both buy and sell
(6)
Sell no buy
(7)
Flow volatility
7.645**
(3.156)
0.329***
6.852
(4.429)
0.328***
15.01***
(3.455)
0.222***
(0.0541)
(0.0657)
(0.0594)
0.0174
(0.275)
0.0631***
(0.0163)
0.0943***
(0.0318)
2.005***
(0.510)
0.568***
(0.140)
0.706***
(0.0881)
-0.132
(0.231)
0.770***
(0.0644)
0.581***
(0.0422)
4,073,070
0.131%
0.2425
2,756,756
0.015%
0.2596
4,047,326
0.065%
0.2176
Portfolio turnover
Bond turnover
# CDS contracts
Assets reference entity
# observations
% (Dep var =1)
Pseudo R squared
10
Tests on liquidity management, fund-CDS level, 2/2
•
Intensity of CDS usage
– Controls: fund size, age, performance rank; Lipper fund category dummy; quarter
dummy; hetero. standard errors clustering at fund level
Tobit
Dependent variable
Gross sell
intensity
(1)
Gross buy intensity
Gross sell intensity
Gross buy intensity
(2)
(3)
(4)
1.457
(0.962)
2.895***
(0.342)
2.596***
(0.281)
0.861
(0.729)
0.229***
(0.0668)
0.434***
(0.102)
57.98***
(16.00)
1.016***
(0.250)
1.656*
(0.957)
2.899***
(0.348)
2.603***
(0.284)
22.24**
(9.404)
1.066***
(0.202)
1.028
(0.732)
0.238***
(0.0735)
0.448***
(0.0996)
4,147,385
0.1143
4,147,385
0.0831
4,147,385
0.1714
4,147,385
0.1735
Flow volatility
Portfolio turnover
Bond turnover
# CDS contracts
Assets reference entity
# observations
Pseudo R squared
11
Evidence on the rational of risk taking by PIMCO
• PIMCO Investment Outlook, May 2006, William H. Gross
– “it is important to recognize that General Motors is a canary in this
country’s economic coal mine.”
• TIME, Sep 16, 2008: Even Bond Guru Bill Gross Can't Escape
– “With so many bad assets floating around finance firms, his strategy
had been to only invest in "high-quality institutions under the
umbrella of regulatory protection””
– “On his original list Gross had five deposit-taking banks (Bank of
America, JP Morgan, Wells Fargo, Citigroup and Wachovia) and five
investment banks (Bear Stearns, Lehman Brothers, Merrill Lynch,
Morgan Stanley and Goldman Sachs)”
• Interpretation: PIMCO interested in too-big-to-fail firms.
12
Identification: leader-follower
• PIMCO: the leader
– In t-1 quarter, PIMCO disclosed positions. Our focus is on large net
positions
• Non-PIMCO mutual funds: the followers
– The dependent New Sellingi,j,t (dummy) is equal to one if fund i discloses
CDS net selling in the reference entity j in period t and the fund did not
disclose any net selling position j in period t-1.
– The unit of observation: the fund-reference entity-quarter
– Unconditional/conditional: quarter t consists of all 445/the number of
entities for which fund i did not already have a net short position on in
quarter t-1
– Speculative buy is defined in a similar way
• Test: Whether/How non-PIMCO mutual funds benchmark PIMCO?
– on net selling positions: risk taking
– on speculative buy positions: relative performance evaluation
13
Tests on net selling (risk taking), 9 mutual fund families,
unconditional
•
Logit: Propensity to open net selling position. Control: quarter dummy
Dependent: Non-PIMCO
Net selling
PIMCO Lead (t-1)
Assets Reference Entity (log)
Spread-5year (t-1)
Fund TNA (log)
# observations
% (Dep var =1)
Pseudo R squared
•
2007
(2)
2008
(4)
2009
(6)
0.619***
(0.0996)
0.352***
(0.0261)
38.14***
(1.471)
-0.00151
(0.0321)
0.934***
(0.0951)
0.272***
(0.0221)
6.415***
(0.333)
-0.0886***
(0.0281)
1.698***
(0.216)
0.445***
(0.0523)
0.628*
(0.339)
0.425***
(0.0830)
65,150
0.953%
0.1228
87,999
0.819%
0.0864
64,451
0.163%
0.1403
Similar results for conditional test
14
Tests on net selling (risk taking), 23 mutual fund
families, unconditional
•
Logit: Propensity to open net selling position. Control: quarter dummy
Dependent: Non-PIMCO
Net selling
PIMCO Lead (t-1)
Assets Reference Entity (log)
Spread-5year (t-1)
Fund TNA (log)
Control
# observations
% (Dep var =1)
Pseudo R squared
•
2007
(2)
2008
(4)
2009
(6)
1.356***
(0.136)
0.410***
(0.0350)
24.67***
(2.468)
0.168***
(0.0478)
yes
1.109***
(0.123)
0.433***
(0.0293)
2.979***
(0.605)
0.133***
(0.0390)
yes
2.273***
(0.217)
0.441***
(0.0520)
0.459
(0.305)
0.338***
(0.0688)
yes
98,854
0.281%
0.1063
139,143
0.268%
0.1031
93,472
0.119%
0.2017
Similar results for conditional test
15
Tests on speculative buy (benchmarking leader),
9 mutual fund families
•
Logit: Propensity to open positions on speculative buy. Control: quarter
dummy
Dependent: Non-PIMCO
Speculative buy
PIMCO Lead (t-1)
Assets Reference Entity (log)
Spread-5year (t-1)
Fund TNA (log)
Control
# observations
% (Dep var =1)
Pseudo R squared
2007
(2)
2008
(4)
2009
(6)
0.529***
(0.150)
-0.195***
(0.0349)
-40.16***
(5.462)
0.146***
(0.0369)
yes
71,708
0.708%
0.0253
0.558***
(0.162)
0.0771**
(0.0326)
-3.180**
(1.449)
0.118***
(0.0397)
yes
99,877
0.370%
0.0229
0.728**
(0.289)
0.0779
(0.0630)
-0.964
(1.139)
0.272***
(0.0829)
yes
70,995
0.139%
0.0255
16
Tests on speculative buy (benchmarking leader)
23 mutual fund families
•
Logit: Propensity to open positions on speculative buy. Control: quarter
dummy
Dependent: Non-PIMCO
Speculative buy
PIMCO Lead (t-1)
Assets Reference Entity (log)
Spread-5year (t-1)
Fund TNA (log)
Control
# observations
% (Dep var =1)
Pseudo R squared
2007
(2)
2008
(4)
2009
(6)
1.193***
(0.121)
0.0480*
(0.0290)
-30.85***
(4.998)
-0.0477
(0.0336)
yes
98,359
0.530%
0.0282
0.434***
(0.142)
-0.0402
(0.0311)
-11.56***
(2.237)
-0.172***
(0.0318)
yes
145,288
0.339%
0.0410
0.853***
(0.178)
-0.0300
(0.0438)
-3.206***
(1.142)
-0.0474
(0.0481)
yes
101,437
0.238%
0.0423
17
Conclusion
• Understood the motivation of CDS usage by mutual funds: liquidity
management
• Identified the leader and the followers
• Understood why the leader took sell positions on selective CDSs
• Provided explanations on follower’s positions: benchmarking leader
– Sell positions, risk taking
– Buy positions, relative performance evaluation
– Large vs. small mutual funds.
18