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Fabio Cortes and Luca Sanfilippo
Unconstrained multi-sector bond funds (MSBFs) can be a source of spillovers to emerging markets and potentially exert a sizable impact on cross-border flows. MSBFs have grown their investment in emerging markets in recent years and are highly concentrated—both in their positions and their decision-making. They typically also exhibit opportunistic behavior much more so than other investment funds. Theoretically, their size, multisector mandate, and unconstrained nature allows MSBFs to be a source of financial stability in periods of wide-spread market turmoil while others sell at fire-sale prices. However, this note, building on the analysis of Cortes and Sanfilippo (2020) and incorporating data around the COVID-19 crisis, finds that MSBFs could have contributed to increase market stress in selected emerging markets. When faced with large investor redemptions during the crisis, our sample of MSBFs chose to rebalance their portfolios in a concentrated manner, raising a large proportion of cash in a few specific local currency bond markets. This may have contributed to exacerbating the relative underperformance of these local currency bond markets to broader emerging market indices.
Fabio Cortes and Luca Sanfilippo

Unconstrained multi-sector bond funds (MSBFs) can be a source of spillovers to emerging markets and potentially exert a sizable impact on cross-border flows. MSBFs have grown their investment in emerging markets in recent years and are highly concentrated—both in their positions and their decision-making. They typically also exhibit opportunistic behavior much more so than other investment funds. Theoretically, their size, multisector mandate, and unconstrained nature allows MSBFs to be a source of financial stability in periods of wide-spread market turmoil while others sell at fire-sale prices. However, this note, building on the analysis of Cortes and Sanfilippo (2020) and incorporating data around the COVID-19 crisis, finds that MSBFs could have contributed to increase market stress in selected emerging markets. When faced with large investor redemptions during the crisis, our sample of MSBFs chose to rebalance their portfolios in a concentrated manner, raising a large proportion of cash in a few specific local currency bond markets. This may have contributed to exacerbating the relative underperformance of these local currency bond markets to broader emerging market indices.

Fabio Cortes and Luca Sanfilippo

Title Page MONETARY AND CAPITAL MARKETS Global Financial Stability Notes No. 2021/05 Multi-Sector Bond Funds in Emerging Markets—Easy Come, Easy Go Prepared by: Fabio Cortes and Luca Sanfilippo December 2021 DISCLAIMER : The views expressed are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management. Unconstrained multi-sector bond funds (MSBFs) can be a source of spillovers to emerging markets and potentially exert a sizable impact on cross-border flows. MSBFs have grown

Antonio Garcia Pascual and Jay Surti

relatively marginal in China and India ( Figure 8 , panel 5). 2 At the other end of the spectrum are unconstrained multi-sector bond funds who freely choose portfolio allocations unshackled of benchmark indices. The end-investors in benchmark-driven funds and unconstrained funds such as open-end multi-sector bond funds can be retail or institutional. 3 Almost 30 percent of EM funds benchmarked invest in local sovereign debt, 45 percent invest in EM of-shore sovereign debt and about 15 percent in EM offshore corporate debt. 4 The active share of a

Antonio Garcia Pascual and Jay Surti

specifically targeted. For instance, based on benchmark weights , several EMEs may be estimated to have potentially experienced a drop in fund allocations (USD $1—$3 bn), due to China’s inclusion in the GBI-EM index because of the mechanical rebalancing of the index weights ( Figure 10 , panel 3; IMF 2019 ). 10 Unconstrained Bond Funds Can Also Be a Source of Outflows from EMDEs Notwithstanding their smaller EM presence compared to BDIs, unconstrained multi sector bond funds (MSBFs) can potentially exert a large impact on cross-border flows. 11 As MSBFs are

Antonio Garcia Pascual, Mr. Ranjit Singh, and Jay Surti
The paper’s analysis underscores the importance of the ongoing Financial Stability Board-led process of identifying policy options, involving national authorities and the International Organization of Securities Commissions and other standard setters. In this context, the global nature of the investment fund business and fungibility of financial flows makes it vital to ensure consistency of global policy choices that can secure financial stability by precluding regulatory arbitrage.
International Monetary Fund. Asia and Pacific Dept

declined significantly. In Malaysia, the share of unconstrained multi sector bond funds (MSBFs), — which are highly concentrated–both in their positions and their decision-making and tend to exhibit opportunistic behavior more so than other investment funds, — declined from above 30 percent in mid-2011 to less than 3 percent in 2020 ( Figure 10 ). Figure 8. Foreign Shareholding of Government Debt Securities (Billions of Ringgit (LHS), percent (RHS)) Source: BNM Figure 9. Local currency government debt holdings by benchmark-driven investors (in

International Monetary Fund. Asia and Pacific Dept
Malaysia’s economy is showing signs of a gradual yet steady recovery thanks to the authorities’ impressive vaccine rollout, swift and coordinated implementation of multi-pronged support measures. The recovery nevertheless remains uneven and the output gap sizeable, with significant downside risks. Going forward, the authorities should calibrate macroeconomic policies to the pace of the recovery, while preserving policy space given pandemic-related uncertainties, and simultaneously accelerate structural reforms.