IMF warns funds with illiquid assets pose risk to financial stability

The IMF has warned {that a} surge of outflows from funds permitting frequent investor withdrawals however holding hard-to-sell belongings might amplify market stress and “probably undermine the soundness of the monetary system”.

Withdrawals from open-ended bond funds have elevated in current months, the IMF famous, and one other shock might “set off additional outflows”, with a mismatch between redemptions and illiquid holdings posing a “main potential vulnerability”.

The Washington-based worldwide physique singled out much less incessantly traded securities akin to company bonds, sure rising market belongings and actual property as most in danger in periods of market volatility when traders can transfer to promote in unison.

“Pressures from these investor runs might power funds to promote belongings shortly, which might additional depress valuations. That in flip would amplify the influence of the preliminary shock and probably undermine the soundness of the monetary system,” the IMF wrote in a weblog publish on Tuesday.

A lot of UK property funds moved on Monday to restrict withdrawals, in an indication of how methods based mostly on harder-to-trade belongings wrestle when convulsing fairness and bond markets compel traders to hurry for the exit.

Open-ended funds have grown to handle round $41tn in belongings, or one-fifth of holdings managed by the monetary sector outdoors of banks, prior to now two years. Most of those funds spend money on comparatively straightforward to commerce belongings akin to shares and bonds, however the want to permit traders to diversify has led to the growth of funds with exposures to much less liquid holdings.

These dynamics will also be damaging to rising markets, the place liquidity already tends to be weaker even in additional steady durations.

“A decline within the liquidity of funds domiciled in superior economies can have vital cross-border spillover results and enhance the return volatility of rising market company bonds,” the IMF mentioned.

Considerations about open-ended funds will not be new. Property funds got here underneath hearth in 2016 and once more in 2020 when the respective shocks of the Brexit vote and the outbreak of the pandemic compelled numerous them to gate, locking in tens of billions of kilos of investor funds.

Within the aftermath of the UK’s vote to depart the EU, traders regarded to drag out of the funds. Property autos holding £15bn, run by managers together with Normal Life, Aviva and M&G, suspended buying and selling when confronted with a wave of redemption requests.

Funds have been additionally “gated” in March 2020, trapping greater than £20bn, when the disruption attributable to coronavirus left property valuers unable to precisely worth belongings.

The UK’s Monetary Conduct Authority requires fund managers to contemplate suspending property funds in excessive market circumstances to permit an orderly sell-off of belongings.