Market Mayhem Meets Liquidity Mismatch: “At Least” 76 Mutual Funds in Europe Were “Gated” in March

Due to “the interconnectedness of the financial system” fund gatings can trigger “contagion risk” with “the potential to become a systemic issue”: Fitch

By Nick Corbishley, for WOLF STREET:

The mass shuttering of open-end mutual funds, a problem that has dogged the UK’s fund industry for months, appears to have crossed over to multiple fund industries in mainland Europe. According to Fitch Ratings, “at least” 76 European mutual funds, with an estimated $35 billion of assets under management (AUM), suspended redemptions in March after investors scrambled for the exits. Almost £9 billion was pulled from UK-based funds alone, more than any other month on record.

Fitch was able to identify the gated funds by scrutinizing their respective investment managers’ disclosures. But the actual scale of the problem is likely to be a lot larger than the numbers suggest. “The true extent of gating is even greater given that funds’ public disclosures are limited,” Fitch said. According to the European Securities and Markets Authority, funds totaling €100 billion in AUM suspended redemptions or applied other extraordinary liquidity measures in March.

Here’s a breakdown (by fund manager location, fund domicile and fund type) of the 76 gated funds identified by Fitch

Fund manager location: Almost two-thirds of the funds (53) were managed in Denmark. Fifteen were managed in the UK, five in Sweden and one a-piece in Finland, Norway and France. The preponderance of Scandinavian countries in the sample may reflect higher disclosure standards for fund managers in the region, Fitch says. In other words, other parts of Europe may also have growing numbers of gated funds that just haven’t been publicly disclosed yet.

Fund domicile, Luxembourg accounted for almost half (36 out of 76) of the gatings, reflecting the country’s dominant position as a domicile for mutual funds. The UK and Denmark respectively boasted 17 and 16 domiciled funds, while Sweden (5), Finland (1) and Norway (1) accounted for the rest.

Types of the gated funds:

  • 15 funds, all UK-based, were in commercial real estate (AUM of €23 billion);
  • 30 funds were in fixed income (AUM: €10.5 billion);
  • 23 gated funds were equity funds (AUM: €1.4 billion);
  • 5 funds were mixed funds (AUM: €1.9 billion).

Don’t Mention the “L” Word

“Widespread gatings like this are rare and the only comparable examples were during the 2008 financial crisis and following the 2016 Brexit vote,” Fitch said.

In the aftermath of the Brexit vote, six commercial real estate (CRE) funds gated. This time round, 15 CRE funds have so far shut their doors. Most of these were retail funds that offered daily redemptions though a few, such as the £3.4 billion BlackRock UK Property, were aimed at larger institutional clients and offered only monthly or quarterly redemptions. Combined, the gated funds account for roughly two thirds of all assets under management in the UK open-end property fund industry.

The official reason cited for the shuttering of these funds is that it is currently impossible to accurately value the funds’ real estate assets amid the market mayhem being caused by the response to Covid-19. Many of the open-end funds also probably suffered serious liquidity problems after sustaining significant outflows of investor money. They just don’t want to admit as much. As Fitch says, “even if the daily-dealing funds that gated recently had managed to avoid valuation issues, they would have had to gate anyway to prevent a surge in outflows.”

A sudden surge in outflows can be fatal for an open-end mutual fund, especially one with illiquid assets. When investors take their money out, the fund has to use up its remaining cash and then has to sell assets in the portfolio to raise money to meet the redemptions. In the case of commercial real estate, those assets can take months or even longer to sell, particularly in a downturn. This gives rise to that infamous “mismatch in liquidity” between what the fund offers to its investors (daily liquidity) and what the fund holds (largely illiquid assets).

Eventually, the fund runs out of cash and has no choice but to close its doors, leaving investors trapped and having to contemplate heavy losses. This is what happened to investors of M&G Investments’ £2.5 billion direct property fund, which gated in December 2019 after reporting “unusually high and sustained outflows.”

Rising Contagion Risk

Now, four months on, as more and more funds are following in M&G’s footsteps and shutting their doors, no one is talking about “outflows of funds” or “liquidity issues”, for one obvious reason: contagion risk.

Most of the gated funds in Scandinavia have adopted the same line used by the UK funds, blaming their decision to suspend redemptions on acute valuation problems. “The vast majority of gatings were driven by issues in pricing underlying securities across asset classes,” says Fitch. “There was even one case of an exchange-traded fund suspending trading due to pricing issues. Several funds have reopened but some are liquidating.”

In Europe, virtually all mutual funds operate with some degree of liquidity mismatch, with the vast majority offering investors daily liquidity with settlement within two or three days, notes Fitch. Some of those funds will have more cash and liquid assets on hand than others and will be better positioned to withstand heavy outflows. But as the recent saga involving the now-defunct £3.7 billion Woodford Equity Income Fund showed, even funds that claim to invest in highly liquid assets may be lying.

The good news, according to Fitch, is that the recent spate of fund gatings in Europe “does not pose an immediate threat to the broader financial system”. The volume of funds that have so far gated is a drop in the bucket compared with European mutual funds’ total assets under management, which were equivalent to around €16 trillion at the end of 2019.

The bad news, according to Fitch, is that “the interconnectedness of the financial system means that fund gatings can spread, giving rise to contagion risk.” This echoes earlier warnings from the Bank of England’s Financial Policy Committee that the liquidity mismatches of open-end mutual funds “can create an incentive for investors to redeem when they expect others to do so.” If this dynamic snowballs, it “has the potential to become a systemic issue.” By Nick Corbishley, for WOLF STREET.

“Some forced selling is highly likely.” Read… Mainland Chinese Stop Buying Hong Kong Residential Properties, Try to Unload What They Have, Prices Follow

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  54 comments for “Market Mayhem Meets Liquidity Mismatch: “At Least” 76 Mutual Funds in Europe Were “Gated” in March

  1. John
    Apr 22, 2020 at 12:02 pm

    Wolf,
    Mutual funds and etf’s are the enemy of stocks.

    • Cas127
      Apr 22, 2020 at 3:07 pm

      John,

      Odd how nobody said that when MFs/ETFs were providing upward buying pressure…

  2. Apr 22, 2020 at 12:34 pm

    Gated Fixed Income?

    • Cas127
      Apr 22, 2020 at 3:11 pm

      How about gated *equity*…

      The more liquid the mkt, the less “gating” can be justified for pure liquidity reasons…but pretty sure that any “gating” restrictions have to be disclosed…so share buyers knew what might happen…

  3. Paulo
    Apr 22, 2020 at 12:41 pm

    I’m a little confused on the gating shove. Do all the assets have to be sold first, or is is simply that there are no buyers for the position an investor wants to bail on? Are the funds forced to sell assets simply because investors want their money now, or can the fund managers simply say they cannot redeem your position at this time?

    And, what about management pay and benefits when the funds are in decline. Would there be recourse in the courts for the investor against management or is it just buyer beware, too bad so sad we’re closed now?

    Thank you in advance.

    • MC01
      Apr 22, 2020 at 2:05 pm

      An open-end fund behaves this way: it’s always open to new investments, both from existing investors and new investors. This is great for fund managers.
      Shares in an open-end fund can be either sold on the open market (over the counter; they do not trade on exchanges) or “liquidated”, meaning sold back to the fund itself.

      Open-end fund managers generally maintain a much higher cash position (generally meaning highly liquid short term government bonds) than those held by other mutual funds precisely because they know shares can be redeemed at any time.

      However there comes a time when liquidations hit such a frantic pace that this cash cushion runs out too quickly and fund managers “close the gate”, meaning they stop liquidations of existing shares for the time being.

      Mutual funds can raise more cash by selling their assets but here’s the catch: not all assets they hold are Apple stocks that can be sold in the blink of an eye. In fact the assets held by real estate- and fixed yield-oriented mutual funds tend to be either highly illiquid or have lost a ton of value over the past two months. A typical example are bonds issued by Norwegian Air Shuttle (NAS), which Scandinavian fixed income funds bought with enthusiasm due to the scrap of yield they offered. These bonds are now trading at 33 øre to the krone (“cents to the dollar”), and that’s provided you can find a vulture fund willing to take them off your hands.

      Since open-end mutual fund shares are priced once a day and according to the Net Asset Value (NAV) of their portfolio, most of the folks who put their money into these mutual funds are seeing the value of their shares evaporate as their portfolios take beating after beating. They get nervous and want to cut their losses before their savings evaporate.
      This initiate a vicious cycle that usually ends with the fund manager closing the gate or even the fund collapsing under the weight of liquidations. There’s no bailout coming for these folks.

      Sorry for the long reply but I haven’t got Nick’s and Wolf’s gift for explaining difficult concepts with a few words.

    • Apr 22, 2020 at 3:38 pm

      Paulo,

      These are open-ended mutual funds. If you want to cash out of the fund, you have to sell your shares back to the fund, and the fund has to have the cash to pay you. The fund will normally have some cash balance on hand to meet this redemption requests. But once the cash runs out, the fund has to sell assets (such as bonds or real estate holdings) in the market to raise the cash to pay for redemptions. But selling them can take a long time because these assets are often illiquid and cannot be easily sold.

      That’s when you get the “run on the fund.” They are terrible for fund holders. “Gating” blocks redemptions, and investors CANNOT cash out and they’re stuck. And they might eventually get some portion of their money back, such as 60 cents on the dollar, after all assets have been sold.

      I HATE these open-ended mutual funds with illiquid assets, such as junk bonds or real estate. A bunch of big bond funds blew up that way during the Financial Crisis, including some big funds from Charles Schwab, and investors got totally crushed. I explained the whole thing here:

      https://wolfstreet.com/2019/10/28/first-mover-advantage-run-on-the-fund-liquidity-mismatch-big-risk-of-bond-loan-mutual-funds-what-smart-investors-do/

      • Paulo
        Apr 22, 2020 at 7:52 pm

        Thank you both for the explanation. I was stuck comparing to some of the past mutual funds I owned and sold. It took me about 4 days to liquidate, if I remember correctly. I didn’t understand the open end concept.

  4. Ron Kallhoff
    Apr 22, 2020 at 12:42 pm

    Let’s talk about the biggest ponzu schem ever created its a401 k working people in vest there time and labor for a future payment but in last 20 years have not gotten a return on investment while all the rich keep buying houses in hamptons and luxurY apartments in NYC stop the madness quit giving thief’s your money to support there lifestyle

    • 2banana
      Apr 22, 2020 at 3:41 pm

      The Hamptons and Luxury NYC apartments have been hammered the last two years.

      And, my guess, will be fully crushed in 2020-2021.

    • Steve
      Apr 23, 2020 at 6:44 am

      And defined benefits plans are not a ponzi scheme either? Defined Benefit or 401k, either way you take a risk. Big difference is one is portable.

  5. Yancey Ward
    Apr 22, 2020 at 12:43 pm

    Yes, the excuses are all lies. They simply don’t have the cash to honor immediate withdrawls.

  6. Joe
    Apr 22, 2020 at 12:51 pm

    Read something weird were some company is reverse splitting were it takes 6 stocks to get one redemption…

  7. Tim
    Apr 22, 2020 at 12:54 pm

    Fear is contagious…

    • Unamused
      Apr 22, 2020 at 2:34 pm

      . . . and there’s no vaccine.

    • WES
      Apr 22, 2020 at 5:38 pm

      Tim:

      And the fear is driven by “lost of trust”!

  8. 2banana
    Apr 22, 2020 at 1:01 pm

    Why is Jon Corzine, still a free man, just laughing at all this?

    ““at least” 76 European mutual funds, with an estimated $35 billion of assets under management (AUM), suspended redemptions in March after investors scrambled for the exits.”

    • p coyle
      Apr 23, 2020 at 2:09 am

      because corzine wouldn’t be a free man if his head had been properly displayed on the end of a pike somewhere on wall st. where other miscreants would have to see it on their way to the office?

  9. Tim
    Apr 22, 2020 at 1:05 pm

    What I just couldn’t get my head around was the balls of it all in the case of Woodford Equity Income Fund.

    ‘They won’t ever actually want their invested money back in, substantial numbers, because, hey, we’re soo good at this they’ll always believe us..’

    I’m not saying that such businesses are or were Ponzi schemes, but I wonder if there was a similar psychology of bluffing.

    • Tim
      Apr 22, 2020 at 1:06 pm

      That’s an imagined quote, by the way.

  10. Joe
    Apr 22, 2020 at 1:57 pm

    If you could pump out nurses or healthcare workers right now, Quebec, Canada is so short due to not being prepared, that the called in the 1,000 military soldiers on top the military’s own health aids. 2 reported walk off the jobs workers at aged private healthcare homes. No doubt that this is a chronic problem across this province.

  11. Jdog
    Apr 22, 2020 at 2:03 pm

    This is the worst scenario for the stock market. People who cannot access money they need are losing trust in the system. The leverage in the system is now working in reverse, and all the shady practices that have become common are now blowing up. The entire market is built on a foundation of financed buy backs and overvaluations… How many people who are within 10 years of retirement are now having cold feet. How much of the money from paycheck contributions to 401K’s have simply stopped.
    The oil industry is a disaster, so are automakers, cruise ships, restaurants, theaters, retail stores, airlines, hotels, casinos, sports franchises, car rentals, and all the suppliers to all these industries.
    Many companies in these industries will not survive, and their share prices will go to 0. Many of the rest will have negative earnings and be downgraded making their situations that much worse.
    Why anyone would think their money was safe in the market is a mystery to me.

    • Frederick
      Apr 22, 2020 at 2:35 pm

      Funny I lost trust in the system in 2001 and again in 2008 Foolish me

      • WES
        Apr 22, 2020 at 5:45 pm

        Frederick:

        Just don’t drop any “trust” on your fingers or toes!

        They can hurt like hell!

        From a kid once let loose in a vault!

    • 2banana
      Apr 22, 2020 at 3:46 pm

      If you need quick access to money, you should not be invested in these securities.

      If you are within 10 years of retirement, you should not be invested in these securities.

      Treasuries, CDs, money markets, munis, etc. pay next to nothing, but at least you will get your principle back.

      At age 55-60, at least 50% of your assets should be in these fairly safe securities.

      • Willy Winky
        Apr 22, 2020 at 7:06 pm

        But if you invest in ‘safe’ securities there are miniscule returns … so you live on a diet of cat food.

        It is not difficult to understand why most people are unwilling to take the ‘safe’ option.

        • p coyle
          Apr 23, 2020 at 2:15 am

          well, you can always invest in risky assets like seeds, and arable land, and avoid the diet of cat food. lord knows that cats don’t like their veggies.

        • Steve
          Apr 23, 2020 at 6:56 am

          Coyle is dead right.

          Of course this will require quite a bit of sweat and the occasional aching back. But the results are tangible and substantial year end and year out. Don’t even need soil if that is an issue.

          Nothing is free.

    • MC01
      Apr 22, 2020 at 4:27 pm

      Jdog: while many of these open-end mutual funds own stocks of one sort of another, they are a completely different thing from the stock and bond markets.
      These particular mutual funds don’t even trade on exchanges but over the counter and they are priced once per day based on the NAV (net Asset Value) of their portfolio. That’s why people want out: they check their investment and get scared as they see losses pile up and want out right now.

      With stocks and especially bonds this is not a big issue: if you are ready to take whatever vulture funds are offering you can sell almost anything. But this stuff is different: the moment the rumor is out the fund has become gated you cannot get your money out anymore and buyers pull a disappearing act. There’s no market for this stuff anymore.

      Make no bone about it: many, many companies will land in serious financial troubles over the next 6-8 months. But how many will effectively disappear is another matter: companies that will enter Chaper 11 will most likely wipe out shareholders and end up with senior creditors as the new owners. Other companies will restructure their debt and bondholders will be forced to take major losses to avoid the uncertainty of a liquidation. And finally there will be the fire sales, the Chapter 7 bankruptcies and the voluntary liquidations.
      Somebody will be picking up assets literally for cents to the dollar: I hope to get some crumbs as well. I usually have a frugal appetite but this long lockdown is making me really hungry.

      • Jdog
        Apr 22, 2020 at 6:58 pm

        The point is that the equities that make up these funds are in trouble, and the funds having limited liquidity only makes this situation worse.
        The minor correction we have seen, is only a precursor for what is to come IMO.

    • nigel harrison
      Apr 22, 2020 at 6:42 pm

      Markets go up and markets go down. Some downs are worse than others. Liquidating your position if you are able to and putting your money in the bank. Watch out for the banks. I hope whatever countries banking regulatory regime in which you are living is strong enough that the too big to fail banks are sufficiently strong not to fail. Here in NZ I’m not so sure.

  12. Iamafan
    Apr 22, 2020 at 2:14 pm

    I’m a bit confused. Is anyone suggesting that the government should become a nanny to public mutual fund investors. Isn’t Caveat Emptor enough? I have a personal rule, if it’s too conplex to understand, I don’t bother. I just social distance away.

    • Unamused
      Apr 22, 2020 at 2:57 pm

      Is anyone suggesting that the government should become a nanny to public mutual fund investors.

      Why not? The Fed bailed out the entire casino. Why can’t they gift your money to a few stragglers while they’re at it?

      • cas127
        Apr 22, 2020 at 3:23 pm

        “Why can’t they gift your money to a few stragglers while they’re at it?”

        Because for every straggler you subsidize, you get two stragglers tomorrow (has the multi-decade history of the US welfare state increased or decreased risk aversion among the overall population? Individual and corporate.)

        And since the government is infinitely more effective at redistribution (print print print) than creation (erm, ventilators…) the snowballing effects of counter-productive subsidization of poor risk mgt, brings systemic collapse closer and closer.

        If the public ultimately dumps the dollar due to runaway inflation (how many real goods have the trillions in bailout funds incrementally created?) how can DC save anybody?

        • Rev GJ
          Apr 22, 2020 at 6:50 pm

          that was a wonderful post…

    • Apr 22, 2020 at 3:48 pm

      Iamafan,

      No one is suggesting that “the government should become a nanny to public mutual fund investors.” But I’ve been screaming (not just suggesting) for years: DO NOT invest in an open-end mutual fund that holds mostly illiquid assets such as real estate, leveraged loans, or junk bonds. Those suckers are an evil risk that is not properly disclosed in bold font right on the front (it is alluded to in small print in the prospectus that no one reads). During the Financial Crisis, numerous of those funds have imploded, including some big flagship funds from Charles Schwab, which ended in huge class-action and individual lawsuits.

      Here is the detail of why I hate them:
      https://wolfstreet.com/2019/10/28/first-mover-advantage-run-on-the-fund-liquidity-mismatch-big-risk-of-bond-loan-mutual-funds-what-smart-investors-do/

      • Tim
        Apr 22, 2020 at 5:54 pm

        Oh absolutely.

        But hubris is always curiously beguiling.

        Sell an idea – say time share in Spain where you’ll always have a great time that won’t be hard to arrange for when you want it. Don’t worry about all those other people who have a share, they’ll be reasonable and will only want to use ‘your’ apartment when you don’t.

        And people will come. They will come because they want it to be true. And people who want something to be true most certainly do not want reality to impinge upon their dream (which through dog-leg thinking somehow then becomes their entitlement, their right)

        Which is all absolutely not a problem if a project can actually deliver (bet there are one or two out that there, if no one ran for the door, would actually continue to deliver as they said they would). But you have pointed out so many times, it only needs a small number…to dare to have doubts.

        • Tim
          Apr 22, 2020 at 5:57 pm

          These times of investment are essentially very pretty boxes that may or may not have a dead cat inside them.

          As long as no one looks further than the pretty box… all’s well.

        • Tim
          Apr 22, 2020 at 5:59 pm

          *types of investment.

      • Apr 23, 2020 at 10:59 am

        At the end the day all investments, including the S&P can be gated. Small differences make large outcomes, like the standard MM fund vs treasury MM fund in 2008. Perhaps the line has been drawn here, or perhaps treasury MM funds are toast as well, it just took a bit longer. By inference the size of the nanny state mutual funds grows more cumbersome at each turn. With REPO and QE underutilized, and no authority to bail out mutual funds, the time frame to the final “all gated” solution has been moved up. If they close the stock market, the futures market will destroy what’s left, as we saw in oil.

  13. Mad Puppy
    Apr 22, 2020 at 3:02 pm

    This time, I think there will need to be jailings or more in the financial industry realm. Last time, people lost homes and large chunks of their life savings with no real consequences for the shysters. More of all that and some family members’ deaths thrown in may change all that. Also, people won’t have to look to hard to find all the perpetrators. They have been abundantly visible. Maybe having the “money changers” slip back into the shadows where they belong might be a positive from this crisis. We may yet again come to appreciate people who grow or produce real things of value.

    • 2banana
      Apr 22, 2020 at 3:54 pm

      “Not only too big to fail. Too big to jail.”

      — Eric Holder theory of bank consequences

  14. Cruiser
    Apr 22, 2020 at 4:23 pm

    Collapsing financial markets can be thought of as burning buildings, with one key difference. To flee collapsing markets you first must find someone to take your place. Hence once everyone “smells the smoke” liquidity evaporates and panic ensues. This process has played out many time through history; aside from the mind numbing magnitude of the distortions, this instance will be no different.

    Someone must hold the financial paper all the way down and, given that there are oceans of such paper sloshing around out there, that means most everyone.

    • 2banana
      Apr 22, 2020 at 4:34 pm

      Seems like the only winning move is not to play the game.

      • Cruiser
        Apr 23, 2020 at 3:59 am

        Financial wealth must be placed in something, and currency is being rapidly debased so it isn’t going to be a safe haven. During an inflationary secular financial collapse tangible assets offer refuge. To stay liquid that means precious metals.

  15. Apr 22, 2020 at 4:46 pm

    good

  16. Tim
    Apr 22, 2020 at 5:57 pm

    These times of investment are essentially very pretty boxes that may or may not have a dead cat inside them.

    As long as no one looks further than the pretty box… all’s well.

    • Debt Wazoo
      Apr 22, 2020 at 6:36 pm

      > These times of investment are essentially very pretty boxes that may or may not have a dead cat inside them. As long as no one looks

      … Dr. Schrödinger’s cat will be just fine.

  17. Counterpointer
    Apr 22, 2020 at 5:58 pm

    “Dey pirates yes they rob I, sell I to the merchant ship”

    Redemption Songs, all I ever had…

    It’s got that early 2008 feel about it.

    C

  18. WES
    Apr 22, 2020 at 6:14 pm

    I realize gating $35 billion is considered small potatoes, but the ripple effects can be very unsettling and occur where one least expects it.

    So a small investor can not get access to his money. Supose some cash is needed to pay due property taxes.

    What does the small investor do? My guess sell something else to raise the needed cash. What if the wrong thing is sold?

    Or the property taxes just remain owing?

    Now the existing “cash” problem is simply transferred somewhere else!

  19. SocalJim
    Apr 22, 2020 at 6:58 pm

    This is why every investor must keep a percentage of their assets in cash equivalent securities … when you need cash, last thing you want to do is dump shares in an illiquid mutual fund portfolio. Finance lesson 101, day 1.

    • Jdog
      Apr 22, 2020 at 7:06 pm

      That way after you have lost most everything you had in equities, you will at least have a little cash

      • Cruiser
        Apr 23, 2020 at 4:03 am

        Cash is now rapidly being debased around the world. Not going to be a safe haven.

  20. Aussie Andy
    Apr 22, 2020 at 6:59 pm

    The investor is the problem,as their investments in other products or personal assets needs a buffer,cash injection or they just panic. Perhaps they should rewrite the rules and make withdrawing from a fund a 3 or 6 month wait, so they know what they are getting into in the 1st place. Rather than thinking I can get out tomorrow if I like. Take the sizzle out of the steak and make it a slow roast.

Comments are closed.