FI Analysis No. 37: Stress tests of funds’ liquidity risks

Summary

The outbreak of the coronavirus pandemic in the spring of 2020 demonstrated that funds offering daily redemptions may have difficulties handling large outflows if their assets cannot be sold easily, quickly and in large volumes without having a major impact on the price. In order to be able to analyse the funds' resilience, FI developed a stress test tool based on simulations of large outflows and funds' capacity for handling these flows by selling various assets.

We summarise the results through two simple fund-level key indicators: redemption coverage ratio and liquidity shortfall. Our results tests show that a majority of the Swedish funds appear to be able to handle relatively large outflows in an effective manner. However, a small percentage (9 per cent) of corporate bond funds and a relatively large share (38 per cent) of high-yield bond funds may experience liquidity problems under stressed market conditions according to our calibrations. This is mainly because the managers of these funds generally invest in less liquid assets.

Our results also show that there has not been a large change in fund allocations between 2019 and 2022 in terms of liquid assets, despite the problems that arose during the pandemic. Instead, high-yield bond funds are somewhat more vulnerable today than before the outbreak of the pandemic.

Short-term fixed-income funds can impact the market if they are large enough, even if they appear to be resilient according to our stress tests. Due to their large net asset value, they can contribute to risks in the financial system during large sell-offs of corporate bonds.