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Laxman Pai, Opalesque Asia:

The European high-yield bond fund sector "appears to be operating with significant liquidity risk", Fitch Ratings has cautioned.

The credit rating agency analysed Europe's five largest UCITS high-yield bond funds, with combined assets under management of EUR43bn at end-March 2019.

The funds all offer daily dealing but their holdings of highly liquid securities are limited.

"We found substantial variation across funds, but on average only 4% of their investments were in cash and only 14% in instruments rated 'A' or above, with 'AAA' the lowest allocation," it said.

Duration averaged three to four years for these funds, depending on the extent to which they included floating-rate securities in their portfolios.

Most funds offer daily liquidity to investors despite limited allocations to highly liquid investments.

The recent gating of the Woodford Equity Income fund, which had material holdings of unlisted equities, highlights the dangers of offering high liquidity while investing in less-liquid securities, including forced asset sales, material net asset value reductions, gating and potential knock-on effects to the broader financial system.

High-yield bond funds are just as likely as government bond funds to offer daily liquidity. To counterbalance the lower liquidity of high-yield securities, they need a diverse investment portfolio to reduce the likelihood of having to divest holdings in distres......................

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