The Sector Liquidity Timing Ability of Bond Mutual Funds

ABSTRACT We investigate whether bond mutual fund managers exhibit market liquidity timing skills in the U.S. corporate bond market. At the portfolio level, we find only weak evidence that bond funds adjust their overall market exposure in anticipation of changes in corporate bond market liquidity. In contrast, when liquidity timing is examined through sector allocation strategies across investment grade, high‐yield, and mortgage‐backed securities (MBS) sectors, we find strong evidence of high‐yield sector liquidity timing ability—fund managers overweight high‐yield bonds as corporate bond market liquidity improves. Using individual fund level analysis, we find that top‐ranked bond funds demonstrate market liquidity timing skills with respect to both the overall market and all three sectors. Bootstrap analyses indicate that these liquidity timing skills of bond fund managers are unlikely to be driven by luck. Moreover, we find evidence of persistence in sector liquidity timing ability over time, especially for high‐yield sector timing. Finally, these sector liquidity timing strategies help predict future fund performance.