The suitability of enabling daily dealing for the vast majority of Ucits bond funds has been called into question as a report warned “fund liquidity mismatch risk” had reached its highest ever level this year.
In a Fitch Ratings report, Fund liquidity management: progress and pitfalls, authors Manuel Arrive and Alastair Sewell noted the likelihood and impact of fund liquidity mismatch risk had “increased to its highest level ever in 2016”, raising questions about bond fund requirements.
“Frequent bouts of volatility accompanied by redemption spikes and rapid falls in bond prices this year raise questions about the suitability of daily dealing offered by 90 per cent of Ucits bond funds,” they added.
“In addition, drawdowns resulting from fire sales in illiquid markets increasingly put fund capital at risk, as bond carry returns have become insufficient to offset volatility.”
While the two Fitch analysts acknowledged progress had been made in liquidity risk measurement techniques, stating these had become “more sophisticated, consistent and better documented at asset managers”, they warned that the predictive power of such tools may fall short in times of stress.
The report also claimed that investment strategies were becoming “increasingly constrained by the obligation to implement them in the most liquid way”, leading to unintended negative consequences such as over-diversification and undesired counterparty risk exposure, while fixed income managers had become biased toward more liquid bonds and typically ran higher cash balances than before.
The issue of bond market illiquidity has become a common bugbear for asset managers and regulators.
Last year the issue came up when US asset manager Third Avenue gated its $800m Focused Credit fund in order to meet redemption requests in an orderly fashion. But disputes have arisen over the extent of the problem.
In March the FCA published an occasional paper, with the authors asserting liquidity in the UK corporate bond market had not decreased following the financial crash. But TwentyFour Asset Management’s Chris Bowie accused them of trying to “re-write history”, claiming the findings were at odds with fixed income managers’ experience.
However, in August the International Organization of Securities Commissions, an umbrella body for financial regulators, appeared to back the FCA paper, claiming it had detected no “substantial evidence” of a major decline in bond liquidity from historic norms.
