The likelihood and impact of a liquidity mismatch in money managers' strategies has hit an all-time high, with volatility, spikes in redemptions and rapid falls in bond prices increasing the focus on the issue, Fitch Ratings warns.
The credit ratings agency said in a report Monday that these factors have increased money managers' focus on the effectiveness of liquidity management, as well as the suitability of daily dealing, which is offered by 90% of undertakings for collective investment in transferable securities bond strategies.
The report primarily relates to credit strategies, but other strategies are also at risk when an asset class is less liquid and does not fully match the liquidity profile of the strategy, such as small-cap equities and convertibles, a Fitch spokeswoman said.
The report said that drawdowns as a result of fire sales in illiquid markets are increasingly putting capital in these strategies at risk, as carry returns offered in bond strategies “have become insufficient to offset volatility.”
Money managers have increasingly worked to better embed liquidity risk management into their investment processes, but there have been few developments in redemption terms and conditions for open-end strategies.
The need to meet redemption requests in accordance with these terms and conditions “has pushed asset managers to implement their strategies in the most liquid way,” the report added. Fitch's research found that the fixed-income universe of money managers is biased toward more liquid bonds, typically consisting of large, recent issues by benchmark constituents. This partially excludes “a substantial proportion of the bond universe that effectively rarely trades. Since large funds typically cap their exposure at 10% of an issue outstanding, some funds exclude from their eligible investment universe issues where the outstanding size falls below a certain threshold.”
Use of derivatives has also increased, with large fixed-income strategies in particular increasingly using standardized liquid, cost-efficient derivatives to quickly adjust portfolio exposures during periods of lower liquidity.
