Asset managers and investment funds are among the main holders of low-rated collateralized loan obligations. Given the increasing risks of a sustained global economic downturn as a result of Covid-19 highly leveraged companies could face difficulties in servicing their debt, with possible downgrades to high-yield bonds. There are pockets of high leverage in the (alternative) investment fund sector, which could amplify the impact of market volatility on funds’ portfolios.
In this first quarter of FY 2020, rapid market declines in response to Covid-19 led to sharp mutual fund outflows after months of inflows. Funds had to sell bonds to redeem investors who caused an outflow of almost $240 billion. There was a rush out of prime money market funds, which invest in corporate debt, to the safety of government funds.
Systemic risk is rising, and some mutual funds have had to suspend redemptions due to coronavirus-driven market stress. High valuations in some asset classes may trigger future market corrections. During these uncertain times asset add fund managers should plan for how best to manage the liquidity and valuation risks in their funds.
Additionally regulatory focus which was put on the back burner in 2020 due to Covid-19 will continue to increase within 2021 and beyond, with firms having to make corresponding increases in risk, valuation, and compliance staff and/or hire specialist skill firms/resources to cope with increasing regulator demands and the challenges of implementing regulation effectively.
Regulators are turning their attention to asset managers, scrutinizing their risk culture and governance, interactions with customers and effectiveness in implementing required regulatory changes. The costs of not successfully meeting these challenges are likely to be increasingly significant in terms of monetary fines and reputational damage, both of which the industry can ill afford.
Ocean Tomo recommends that fund and investment managers put into place various steps to navigate these uncertain times. Highlights below. For a fuller list please download the paper here.
- Periodic assessment of the portfolio structures, liquidity (cash) buffers at hand
- Ensuring appropriate stress tests are being conducted and dynamic scenarios considered
- Monitoring and analyzing the funds investor base, behaviors, potential concentration risks
- Timely valuations of NAV’s, adjust NAV with swing pricing
- Among others
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