OREANDA-NEWS. Fitch Ratings says in a new report that UCITS fixed income mutual funds show next to no differentiation in the liquidity they offer investors, despite the differences in liquidity in the underlying asset classes in which they invest.

Liquidity or its lack thereof in the fixed-income markets is a key issue for financial regulators and many investors. In particular, there is a focus on how regulated collective investment schemes manage potential asset-liability mismatches, especially when investing in less liquid asset classes.

Fitch estimates that over 90% of UCITS bond funds offer daily dealing overall. That ratio rises in less liquid asset classes such as high yield and emerging markets, to 96% and 98%, respectively. On the other hand, certain proxies for fund liquidity - such as maximum drawdown and volatility - show clear differences in market liquidity across fixed-income sectors, with high-yield and emerging markets indicating less liquidity than investment-grade corporates.

The ubiquity of daily dealing (combined with settlement three days later) implies investors have become accustomed to a high level of asset allocation flexibility in UCITS mutual funds. This is exacerbated by market structure, with many fund portals only allowing daily dealing and forcing funds to "internalise" the cost of liquidity.

Fitch believes some funds may be challenged to meet this daily dealing market convention in certain less liquid asset classes in periods of stress. UCITS funds have access to various mechanisms to manage liability-side liquidity. These include the ability to offer liquidity as infrequently as every two weeks, swing pricing, liquidity fees/gates and redemption in kind. However, many available liquidity management tools are under-used.

Positively, 94% of high-yield funds we sampled could implement swing pricing based on their governing documentation, compared with 63% of investment-grade funds. However, details of how and when swing pricing may be applied can be difficult to identify and understand in complex fund governing documentation.