By Mackenzie White | Ivey Research Office | August 27, 2025
Shyam Venkatesan
Dr. Shyam Venkatesan’s new research showcases that improving market liquidity reduces the likelihood of coordinated bond fund redemptions, thereby enhancing financial stability and mitigating systemic risk.
During the chaos of the COVID-19 pandemic, financial markets worldwide endured unprecedented turbulence. Among the many shockwaves was a particularly troubling phenomenon: massive, synchronized outflows from bond mutual funds that shook the stability of fixed-income markets. This frenzy of investor redemptions threatened to turn a health crisis into a financial disaster.
Assistant Professor of Finance Dr. Shyam Venkatesan, an expert in financial intermediation at Ivey Business School, was captivated (and concerned) by this market fragility. He was struck by the remarkable coordination among investors rushing for the exits simultaneously during periods of poor fund performance. This behaviour, known as “strategic complementarity,” means investors feel a ‘first-mover advantage” which leads them to redeem before others. This amplifies market stress and leads to fund runs.
Venkatesan’s latest research paper, “Asset Market Liquidity, Strategic Complementarity, and Bond Fund Flows,” tackles a fundamental question: Why do investors act so synchronously, and how can markets be designed to reduce this fragility?
Using a novel natural experiment, his work provides some of the first causal evidence explaining the mechanics behind bond fund runs, and offers insights that could inform regulators, fund managers, and institutional investors alike.
The Origins of a Fragile Market
Venkatesan’s research focuses on financial intermediation: the complex network of institutions like banks, mutual funds, and brokers that mediate between investors and capital markets. Bond mutual funds, as open-ended funds, promise investors liquidity- the ability to redeem shares on demand. Yet the underlying bond assets themselves are often illiquid, meaning selling large volumes quickly can be costly or impossible without impacting prices.
This mismatch creates a dangerous dynamic. When a fund’s performance dips, investors may try to redeem shares, fearing they will be the last to leave. This “rush to the exit” can force fund managers to sell illiquid assets at depressed prices, which further depletes fund performance and can trigger even more redemptions.
Venkatesan explains that previous research suggested that the illiquidity of bond markets fosters these coordinated runs. But the challenge was establishing causality: was it truly market illiquidity driving investor behavior, or were investors self-selecting into funds holding illiquid assets based on their risk tolerance?
Disentangling these explanations is crucial. If illiquidity is the root cause, then improving market liquidity could reduce systemic risk. But if it’s investor self-selection, interventions may need to focus elsewhere.
A Natural Experiment in China's Bond Market
The breakthrough in Venkatesan’s study came from observing the Chinese bond market’s dramatic transformation in July 2017, when China launched Bond Connect, an innovative trading platform giving foreign institutional investors direct access to Chinese bonds, which previously had limited liquidity.
Venkatesan says that this event created an exogenous shock where essentially an outside factor, not related to fund performance or investor sentiment, improved market liquidity. It was the perfect natural experiment to test the theory.
By analyzing fund flows before and after Bond Connect’s introduction, and comparing them to theory and periods of reverse shocks like the Evergrande debt crisis (a massive financial collapse triggered by the Chinese property giant's inability to repay over $300 billion in liabilities, exposing deep flaws in China's real estate-driven economy and shaking global markets), Venkatesan demonstrated that liquidity improvements significantly altered investor behavior. Specifically, the “strategic complementarity” or “first-mover advantage” that drove coordinated redemptions weakened as liquidity increased.
Venkatesan observes that Chinese bond funds exhibited a convex flow-performance relationship, more similar to equity funds, contrasting with the concave pattern seen in U.S. corporate bond funds where outflows accelerate dramatically after poor performance.
This finding upends previous assumptions and highlights how market structure shapes investor responses.
Portfolio Managers and Business Practitioners: Adjusting to a New Landscape
The research also uncovered how fund managers respond strategically to these liquidity changes. When liquidity improves, managers feel less pressured by potential runs and thus reduce costly liquidity buffers (cash or highly liquid assets held to meet redemptions).
Instead, they “reach for yield” by increasing holdings of illiquid assets, which typically offer higher returns but carry more risk.
Venkatesan argues that this makes sense. If redemption risk diminishes, managers optimize for returns by taking on more illiquid positions, which can boost fund performance but might create new vulnerabilities.
This cascading effect underscores the importance of considering systemic interactions between market liquidity, investor behavior, and portfolio management strategies.
Practical Implications for Industry and Policy
For fund managers, the findings emphasize that improving market liquidity can offer greater flexibility and reduce the costs of maintaining liquidity buffers. However, they also highlight the potential for increased risk-taking, which necessitates vigilant risk management and tailored contract designs to align incentives.
Regulators and policymakers gain valuable insights into targeted interventions. Enhancing market infrastructure, such as electronic trading platforms, can effectively reduce systemic risk by curbing strategic redemption behavior. This approach contrasts with broader, blunt tools like redemption fees or swing pricing, which can have unintended consequences.
During the COVID-19 pandemic, U.S. fixed-income funds suffered severe stress partly due to illiquid trading venues. Venkatesan’s research suggests expanding participation in platforms like MarketAxess could mitigate similar crises in the future.
For institutional investors, understanding these liquidity dynamics is critical for portfolio allocation and risk assessment. Funds operating in more liquid markets may offer superior risk-adjusted returns by enabling managers to pursue more opportunistic strategies without triggering runs.
The research drives home a broader message: market design matters profoundly for financial stability. Instead of relying solely on fund-level liquidity requirements, systemic solutions aimed at improving market liquidity tackle the root causes of fragility.
What Lies Ahead: Expanding the Frontier of Financial Stability
Building on this work, Venkatesan is exploring how liquidity dynamics play out in other asset classes and across different regulatory environments. One focus is examining the interaction between liquidity improvements and regulatory tools like swing pricing to understand when and how these policies complement or conflict.
Another promising area is contract design to find the optimal balance between encouraging beneficial risk-taking and preventing excessive exposure.
Venkatesan believes that technological innovations in trading and settlement, especially fintech advances, provide exciting opportunities. Ones that could further reduce strategic complementarities among investors and enhance market resilience.
His ultimate goal is to develop actionable knowledge that benefits both academia and financial markets, helping build systems that withstand shocks rather than amplify them.
Insights Advance Understanding of Liquidity and Risk
Venkatesan’s Bond Fund Flows research uses a rare opportunity to examine the causal mechanism that introduces financial fragility in bond mutual funds. By leveraging natural experiments and rigorous data analysis, his work reveals how improving market liquidity can fundamentally reshape investor behavior, portfolio management, and ultimately, systemic risk.
As global markets continue to evolve amidst technological and regulatory change, these insights will be vital for practitioners and policymakers striving to safeguard stability in an increasingly interconnected financial world.