Investment funds' liquidity tools effective in normal times, need calibration for stress
A CSSF working paper assesses liquidity management tools (LMTs) used by Luxembourg-domiciled open-ended funds. The study finds that while LMTs are effective in normal times, their calibration and operationalization need improvement for stress episodes.
Optimistic assessments and rare suspensions
Luxembourg-domiciled open-ended funds frequently experience redemptions exceeding their cash reserves, indicating a reliance on short-notice asset sales to meet obligations.
A CSSF working paper reveals that fund managers' assessments of asset liquidity under systemic stress scenarios appear optimistic.
While swing pricing is a common tool, effectively passing trading costs to transacting investors and dampening outflows in normal times, its efficacy diminishes during systemic stress.
Conversely, funds rarely suspend redemptions, a measure often preceding permanent closure and liquidation.
This infrequent use, combined with adverse signaling effects and lower survival rates, suggests funds may delay suspensions too long, thereby reducing their effectiveness during critical periods and potentially exacerbating outflows from related funds.
A broad toolkit, selectively deployed
The analysis draws on four CSSF supervisory datasets, merged with Refinitiv Lipper and Bloomberg data, covering Luxembourg-domiciled UCITS funds.
These funds have access to a broad range of liquidity management tools (LMTs).
Data from the first half of 2020 shows nearly all reporting funds can temporarily suspend redemptions (97%) or apply redemption gates (90%).
Approximately 65% can use swing pricing.
Despite this broad availability, LMTs are generally used infrequently.
During the March 2020 market turmoil, only 7 funds suspended redemptions, while 43% used swing pricing, highlighting a selective deployment of these instruments even during periods of elevated investor redemptions.
Potential unfulfilled
The study reveals a critical gap: investment funds have comprehensive liquidity tools, but their full potential remains unfulfilled during market stress.
Reluctance to use suspensions and optimistic self-assessments by managers signal a systemic vulnerability.
Implementing recommended improvements in calibration, timing, and operationalization is crucial for investor protection and fund sector resilience.