Liquidity Management Tools in Investment Funds

Liquidity management tools (LMTs) can help investment funds manage stressed withdrawals, but their benefits depend on how managers calibrate and use them. Simulations of European corporate bond funds show that redemption fees mainly shift liquidity costs to withdrawing investors, while redemption gates can reduce forced selling by limiting immediate access to cash. In the modeled scenarios, the initial market decline accounts for most fund losses.

“Liquidity Management Tools in Investment Funds: Managing Risks from Stressed Redemptions” examines these effects using December 2024 holdings for 668 actively managed European UCITS corporate bond funds with approximately USD316 billion of total net assets.

Policymakers and supervisors designing liquidity management frameworks and fund managers, directors, and boards responsible for managing redemption risks should find this report useful. Its objectives are to help assess how different LMTs affect fund losses and investor access to cash and to inform decisions about tool selection, calibration, governance, and disclosure.

Open-end funds (OEFs) often allow investors to withdraw money daily while holding assets that can be difficult to sell quickly. During market stress, large withdrawals can force funds to sell assets at depressed prices. Those sales can push prices down further, creating additional losses for the fund and other investors holding similar assets. LMTs address the costs and selling pressures associated with withdrawals. They do not prevent the initial market decline.

Managers must balance withdrawing investors’ access to cash with fair treatment of investors who remain in the fund and the need to limit forced selling. Redemption fees can protect remaining investors by charging withdrawing investors for the costs their transactions create. Redemption gates limit how much investors can withdraw at one time, reducing the assets a fund must sell quickly but requiring investors to wait for some of their money.

This report presents stress-test simulations using fund holdings data from LSEG Lipper. Its model traces how an initial decline in asset prices prompts investor withdrawals, leads funds to sell assets, and generates further losses as those sales depress prices.

The study compares outcomes without LMTs with outcomes under a 2% redemption fee and a gate that caps redemptions at 5% of fund net asset value during a redemption window. It also examines different fee and gate settings when managers use both tools together. These settings are modeling assumptions, not recommended levels for every fund.

The simulations assess total fund losses, additional losses from forced selling, and cash paid to redeeming investors. Scenarios draw on asset-price volatility in late 2024 and during the 2022 United Kingdom liability-driven investment crisis, alongside more extreme hypothetical shocks.

• Initial market declines account for most losses. Additional losses from forced selling are relatively small in the modeled scenarios. This finding applies to the sampled funds and modeling assumptions; it does not establish that wider financial-system risks are limited.
• Redemption fees mainly change who bears liquidity costs. A fee reduces the cash investors receive when they redeem, while only marginally reducing total fund losses in the simulations. Assessing these tools therefore requires attention to both their role in protecting remaining investors from redemption costs and their effect on forced selling.
• Redemption gates reduce selling pressure by limiting withdrawals. Under larger modeled shocks, gates reduce forced-sale losses but substantially restrict immediate access to cash. Investors retain the shares they cannot redeem; delayed access is not itself a permanent investment loss. The study does not measure the eventual outcome for those shares.
• Combining tools requires careful calibration. In the simulations, combining fees and gates can further restrict cash paid to withdrawing investors while delivering limited additional reductions in total fund losses. Managers should assess how tools interact across different stress scenarios.

• For policymakers and supervisors, the report recommends flexible frameworks that allow managers to tailor liquidity management tools to each fund while maintaining clear accountability, disclosure, and supervisory oversight. Primary responsibility for selecting, calibrating, activating, and deactivating these tools should rest with the asset manager. Tool selection and settings should reflect asset liquidity, redemption terms, investor concentration, and stress-testing results.
• For fund managers and boards, the report recommends assessing tools individually and together, establishing activation and review procedures before stress occurs, and explaining the implications for withdrawals clearly to investors. Managers should consider both investors seeking cash and those who remain invested.

The study’s analysis covers one round of asset sales within the fund sample. It does not capture repeated rounds of withdrawals or the full range of interactions among funds and other financial institutions. Its findings depend on assumptions about investor responses, asset-sale price effects, and portfolio holdings. The simulations provide a framework for assessing trade-offs, rather than a forecast of outcomes in a future crisis.

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