Bond fund liquidity risk reaches “highest level ever”

European bond fund liquidity risks have reached an all-time high in 2016 according to Fitch Ratings, with 90% being ill-equipped to offer daily liquidity due to redemption spikes and rapidly falling prices.

In a study of Ucits bond funds, the ratings agency found liquidity mismatch risk – the prospect of funds being unable to sell underlying holdings to fulfil investor redemption requests – at its highest level ever.

A low-yielding fixed income market environment is a major contributor to this hazard, as asset managers are progressively seeking returns from investment in riskier, illiquid assets (such as high yield and lower rated corporate bonds).

Furthermore, credit markets in the past three years have suffered frequent, episodic bouts of volatility driven by event risk; during these periods of heightened stress, redemptions rose while bond prices fell, again creating liquidity mismatch risk.

The report notes some fund managers have made efforts to reduce this risk, primarily by growing cash holdings to meet potential redemption requests. Likewise, swing pricing is being used more widely in some jurisdictions. However, Fitch believes the techniques may still prove insufficient to protect investors.

Fund liquidity has increasingly been in the spotlight this year. In April, a major asset management and capital market body issued a report urging EU member states to make as many market-based tools available as possible to support fund liquidity.

Six months later, the groups noted there had been scant tangible progress on liquidity, with industry players at best taking “baby steps”, despite a comprehensive framework being available to managers.

Just how vital liquidity tools can be was underscored in the weeks following the June 23 referendum on the UK’s membership of the European Union, when half the funds in the UK Investment Association property sector were suspended.

©2016 funds europe

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