Fitch: Fund Liquidity Mismatch Risk at a High

Fitch Ratings believes that the likelihood and impact of fund liquidity mismatch risk has increased to a record high in 2016. Frequent bouts of volatility accompanied by redemption spikes and rapid falls in bond prices this year have increased the focus on the effectiveness of liquidity management techniques and the suitability of daily dealing offered by 90% of UCITS bond funds.

In a special report Fitch says asset managers have taken measures to better embed liquidity risk management in their investment process. However, there have been few evolutions in redemption terms and conditions for open-ended funds. This reduces the efficiency of advanced liquidity management techniques and leaves a number of funds vulnerable to severe drawdowns resulting from outflow-driven fire sales in dislocated markets.

Fitch highlights that investment strategies are increasingly constrained by the obligation to implement them in the most liquid manner. This can lead to unintended negative consequences, including excessive portfolio bar-belling, undesired counterparty risk exposure, and over-diversification.

Liquidity is a source of risk but can also be used as a source of returns for asset managers by acting as liquidity providers in one-way markets or by revisiting "buy and hold" credit investment strategies outside of daily liquidity fund structures.

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