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April 12, 2021 11:33 AM

Alternative investment funds faced liquidity squeezes in COVID-19 crisis and 2019

Paulina Pielichata
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    Bloomberg

    European alternative investment funds experienced a sharp drop in valuations at the height of the COVID-19 crisis, causing money managers to suspend redemptions.

    The European Securities and Markets Authority said in a report published April 8 that the net asset value of alternative investment funds declined by 7%, equivalent to €460 billion ($508.6 billion), in the first quarter of 2020. The largest drop was recorded among hedge funds, the report said.

    Valuation issues experienced by some managers led to temporary fund suspensions, with the majority in real estate funds. Most of these funds were based in the U.K. and suspensions were related to valuation uncertainty. However, in several cases the impact of the COVID-19 market stress on real estate funds was not immediately evident. ESMA's analysis of the largest European Union real estate funds — not including the U.K. — showed that 38% of funds or 29% by fund AUM were affected by valuation uncertainties at the end of June, while 42% or 48% by AUM were hit by "material distortions in the incoming cash flows, such as rental income," the report said.

    However, most types of funds surged by 10% or more in size in the second quarter of 2020, when fiscal authorities and central banks announced fiscal stimulus as well as large-scale purchases of corporate and government bonds.

    See more of P&I’s coverage of the coronavirus

    The COVID-19-related liquidity squeeze followed a liquidity mismatch for European alternative investment funds in 2019, with a disparity in the timeframe between requesting a redemption and receiving it.

    ESMA said that liquidity risk was particularly apparent when it came to real estate funds and funds-of-funds investing mainly in equity and fixed-income UCITS funds. These two sets of strategies also recorded the largest asset increases.

    ESMA said in the report that real estate funds are exposed mostly to illiquid physical assets, which take months to sell. However, about 54% of real estate funds are open-ended and almost half of commercial real estate funds offer daily liquidity to investors.

    ESMA also added that 39% of the funds-of-funds' net asset value could be required to be redeemed within one day, but only 29% of assets could be liquidated within the timeframe.

    The report also showed that European Union-based alternative investment funds' assets increased 15% in 2019 to €6.8 trillion from €5.9 trillion in 2018, driven by new fund launches and a positive valuation effect.

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