EU liquidity concern on €6.8 trillion alternative funds

The European Securities and Markets Authority (ESMA), the EU securities regulator, has published its third annual statistical report on the Alternative Investment Fund (AIF) sector, in which flagged a “mismatch between the potential liquidity of the assets, and the redemption timeframe offered to investors.”

The report said the sector increased by 15% in 2019 to €6.8 trillion in net assets from €5.9 trillion in 2018.

Alternative investments can include hedge funds, real estate, funds of funds, private equity, venture capital, managed futures, commodities and derivatives contracts.

“The main risks faced by the sector relate to a mismatch between the potential liquidity of the assets, and the redemption timeframe offered to investors,” said the report.

“This is particularly the case for real estate funds and funds of funds.

“For hedge funds, the issue of leverage is key at more than 900%, in a sector valued at EUR 354bn in net asset value (NAV), including EUR 269bn for hedge funds with UK AIFMs.

“The AIF sector was heavily impacted by the COVID-19 related market stress during the first quarter of 2020, and while outside the reporting period, a snapshot of the main event is included in the report.”

The report said the size of the EU hedge fund sector remained stable in 2019 at €354 billion, or 5% of all AIFs. However, when measured by gross exposures, hedge fund’s account for 62% of AIFs since they rely heavily on derivatives — and their leverage is very high at more than 900% after adjustments, and particularly so for some strategies highly reliant on derivatives.

The report said private equity funds account for 7% of the NAV of all AIFs, or €456 billion, and experienced the largest growth in 2019 (+28% compared with +66% in 2018). They follow a range of strategies and are almost exclusively sold to professional investors.

The ESMA report’s main findings also included:

  • Funds of Funds (FoFs) account for 15% of the NAV of EU AIFs, at around €1 trillion (+22% compared with EUR 841bn in 2018). At the very short end, investors can redeem 39% of the NAV within one day, whereas only 29% of assets could be liquidated within this time frame. If large redemptions were to occur, AIFs would face challenges due to this liquidity mismatch;
  • Real Estate Funds account for 12% of the NAV of AIFs, at €802 billion. They continued to grow, albeit at a more moderate pace (+9% in 2019 after +35% in 2018). Compared with 2018, the proportion of retail investors was stable (21%) but remains high compared with other AIF categories. RE funds are exposed mostly to illiquid physical assets which take time to sell, so liquidity risk in RE funds remains a concern;
  • Other AIFs account for 60% of the NAV of EU AIFs, at around €4 trillion (+15% compared with +6% in 2018). The category covers a range of strategies, with fixed income and equity strategies accounting for 68% of the NAV and an additional residual category amounting to 29%. Other AIFs are mainly sold to professional investors, although there is a significant retail investor presence;
  • EU member states can allow non-EU asset managers to market alternative funds at national level under the National Private Placement Regime (NPPR), even though such funds cannot subsequently be passported in to other members states. The market for such non-EU funds is comparatively large: The NAV of non-EU AIFs marketed under NPPRs’ rules amounts to €2.1 trillion, i.e. more than one-fifth of the AIF market. NPPR fund marketing is concentrated in a small number of member states, and 98% of investors are professional investors.

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Mark McSherry
Dalriada Media LLC sites are edited by veteran news journalist Mark McSherry, a former staff editor and reporter with Reuters, Bloomberg and major newspapers including the South China Morning Post, London's Sunday Times and The Scotsman. McSherry's journalism has also appeared in The Washington Post, The Guardian, The Independent, The New York Times, London's Evening Standard and Forbes. McSherry is also a professor of journalism and communication arts in universities and colleges in New York City. Scottish-born McSherry has an MBA from the University of Edinburgh and a Certificate in Global Affairs from New York University.