This type of risk is more common in down or volatile markets where the fund can
not meet the redemption needs of all the outgoing funds.
In the case of mutual funds, all investors must bear the tax when the fund has to sell securities just to
meet the redemptions of certain shareholders.
Facing redemptions of less than 2 percent of assets, it's possible that many bond funds could have
met redemptions simply by drawing down cash or other liquid assets (after all, bond mutual funds held more than $ 200 billion in short - term liquid assets at the end of May).
Like ETFs, most NextShares
funds meet redemptions through Authorized Participants primarily in kind, 2 meaning that the fund distributes current portfolio holdings of securities rather than cash.
Holding a wad of cash means a fund manager won't be coerced into selling holdings to
meet redemptions from panicky investors.
Then something happens: the fund falls out of favor, all the hot money is flying out, the PM is now selling what he can to
meet redemption requests with those costs again impacting the departing shareholders, but also being born by the long - term shareholders.
All it took was a downgrade, and when the money market funds exercised their puts, they could
n't meet the redemptions, and they were insolvent.
Also, a bond fund is only going to have so much cash on hand, so if the investors in a certain fund all want to redeem their shares of the fund at the same time, it will pose problems for the fund manager trying to
meet redemption requests.
Most likely, the manager will be forced to sell some bonds, potentially at a discount, as the fund needs to simply raise cash to
meet redemptions.
When there is a run on the fund, the fund has to
meet redemptions and sells its most liquid bonds first (Treasuries, etc.) only to then have to sell illiquid bonds that they carried at inflated values, and they have to sell these bonds for cents on the dollar to some hedge fund.
But active equity funds routinely hold securities that are not in that index — small - caps, foreign companies, and most importantly, cash to
meet redemptions.
Investments in small companies can be difficult to sell quickly which may affect the value of the fund and, in extreme market conditions, its ability to
meet redemption requests upon demand.
By avoiding the sale of securities to
meet redemptions, NextShares can potentially reduce fund capital gains distributions and associated shareholder taxes.
It also lessens the likelihood of an active manager shooting himself or herself in the foot by selling the wrong thing at the wrong time because of a need to
meet redemptions, or dare I suggest it, panic or depression overwhelm the manager's common sense in maintaining an investment position (which often hits short seller specialists more than long only investors, but that is another story for another day).
Returning to my own losses last year, The selloff in MLP shares was massively exacerbated by mutual funds, ETFs and — most importantly — leveraged closed - end funds and hedge funds that were forced to liquidate to
meet redemptions or margin calls.
Liquidity can be a concern when there is an asset / liability mismatch in commingled vehicles, and there is a risk that funds may sell illiquid assets to
meet redemption requests.
Under the Internal Revenue Code, when a regulated investment company distributes appreciated assets to
meet redemptions, no gain is recognized by the fund.
By transacting in kind, a NextShares fund can lower its trading costs and enhance fund tax efficiency by avoiding forced sales of securities to
meet redemptions.
This is a hallmark feature of mutual funds and means a fund must be able to convert portfolio holdings to cash on a frequent basis to
meet redemptions.
Open - end funds must maintain cash reserves to
meet redemptions.
To
meet redemption requests, the Fund may be forced to sell securities at an unfavorable time and / or under unfavorable conditions.
Of course, this could have more to do with liquidity issues than diversification since funds have to be ready to
meet redemptions and microcaps don't always provide a lot of liquidity.
(Active managers have a built - in edge in downturns because typically keep a small portion of their portfolios in cash to
meet redemptions, but the benefit was too small to explain why they outperformed.)
While the sound money markets may be perfectly able to
meet redemptions, the result will be rising yields on all types of CP.
While you could get around that by just booking a room in your partner's name, it still will make things much easier when you need to put points together to
meet a redemption.
Many hedge funds are being forced to sell their best debt (the crappy stuff won't sell at all) at well - below value in order to
meet redemptions.