Interfund Lending in Mutual Fund Families: Role of Internal Capital Markets

Abstract

Although the 1940 Act restricts interfund lending within a mutual fund family, families can apply for exemptions from the regulator to participate in interfund lending. We find that heterogeneity in portfolio liquidity and investor flows across funds, funds' investment restrictions, and governance mechanisms determine the applications for interfund lending. We document several costs and benefits of interfund lending after the application. Costs include lower sensitivity of managers' turnover to past performance and greater investor withdrawal for poorly governed funds. Benefits include funds holding more illiquid and concentrated portfolios, and being less susceptible to runs. Finally, well-governed funds perform better.

Liquidity Transformation in Asset Management: Evidence from the Cash Holdings of Mutual Funds

“…A one-standard deviation increase in fund family total assets decreases the cash-to-assets ratio by 1.3 percentage points. As we discuss further below, these economies of scale do not appear to be driven by the fact that larger families tend to have alterative liquidity management tools like lines of credit, interfund lending programs (Agarwal and Zhao, 2015), or funds of funds (Bhattacharya, Lee, and Pool, 2013). Instead it appears that larger fund families have better back office infrastructure that allow them to economize on cash holdings, or that they have more scope to net offsetting trades across individual funds (Goncalves-Pinto and Schmidt, 2013).…”

“…30 However, fund families can ask the SEC for exemptive relief if such borrowing is "appropriate in the public interest and consistent with the protection of investors." Agarwal and Zhao (2015) provide more background on interfund lending programs and study the determinants and consequences of such programs. In particular, they find that as of 2013, only thirty fund families had set up interfund lending programs.…”

Capital Commitment and Investment Decisions: The Role of Mutual Fund Charges

“…Our work contributes to several strands of the literature. We add to the literature that stresses the importance of liquidity management for mutual fund managers (Coval and Stafford (2007), Agarwal and Zhao (2020), and Chernenko and Sunderam (2016)). We show that fee structures can help portfolio managers better anticipate and manage flows.…”