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How Problematic Is Credit Fund Illiquidity?

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A recent article in Alt Credit Intelligence, a subscription-only newsletter that focuses on fixed income strategies, offers an interesting analysis of the liquidity issues surrounding credit funds.

Appearing in the September issue, How Liquid Are Liquid Alts by Benjamin Jaglom examines the regulatory regimes surrounding U.S. and European funds.  Among his findings:

  • In Europe, funds falling under the UCITS structure can have 10% of their assets in a so-called “trash bucket,” which is defined as a non-exchange traded security. Bank loans are included in this category.
  • Liquid alternative mutual funds in the U.S. can hold up to 15% illiquid assets. However, bank loans are considered liquid in U.S. funds and can be held in much greater quantities – even though trading such loans require multiple weeks to settle.
  • UCITs funds can impose redemption “gates” in cash in times of market stress. These discretionary restrictions impose a withdrawal limit of up to 10% of assets daily. Conversely, U.S. mutual funds do not allow gates of any kind.

The leverage allowed in a 40 Act fund adds to investor risks. The article questions if the illiquidity premium boosting returns is sufficient compensation when being tested by a market stress period. 

I have written several times on liquidity in both alternative and traditional bond funds.

Generally speaking, RIAs investing in a fund wrapper that is more easily traded than its underlying security risks a significantly wider bid-ask spread during times of market dislocation. A careful look at a fund’s objectives and portfolio should help advisors sidestep such issues.