28 October 2026
Liquidity is one of the defining features of open-end investment funds. Investors can typically redeem their holdings at short notice, even when the underlying portfolio contains assets that may be difficult to sell quickly. Under normal market conditions, this arrangement generally works smoothly. During periods of financial stress, however, a surge in redemption requests can force fund managers to sell assets at depressed prices, potentially triggering further losses and amplifying market volatility.
How can funds manage these pressures without compromising investor protection?
A new report from the CFA Institute Research and Policy Center, Liquidity Management Tools in Investment Funds: Managing Risks from Stressed Redemptions, by Raymond Ka-Kay Pang, PhD, and Urav Soni, examines this question through an empirical analysis of European corporate bond funds. Its central finding is that liquidity management tools can reduce the impact of stressed redemptions, but their effectiveness depends on how they are designed and implemented. Measures that protect a fund from forced sales may also impose significant costs on investors seeking to withdraw their money.
The liquidity challenge facing open-end funds
The underlying problem is a mismatch between the liquidity offered to investors and that of the assets held by the fund. When redemption requests increase, managers may need to liquidate portfolio holdings to raise cash. If those assets cannot be sold without affecting market prices, the resulting sales can generate additional losses. These losses may spread beyond the original fund. Other funds holding the same securities can experience declines in portfolio valuations, potentially prompting further redemptions and creating a cycle of forced selling. The risks became particularly evident during the market disruption at the onset of the COVID-19 pandemic, when liquidity deteriorated sharply across fixed-income markets. To manage these pressures, investment funds can use liquidity management tools (LMTs), including redemption fees, swing pricing and restrictions on withdrawals. Such mechanisms generally follow two approaches: passing the costs of liquidity to redeeming investors or limiting the amount investors can withdraw during periods of stress. Both can help protect fund portfolios, but they have different implications for investors.
What the research reveals
The CFA Institute study examines 668 actively managed European UCITS corporate bond funds, using portfolio holdings from December 2024. The researchers simulate market shocks and subsequent investor redemptions, assessing how different liquidity management mechanisms affect fund losses and investor liquidity. The analysis focuses on two measures: a 2% redemption fee, which reduces the amount received by investors withdrawing their money, and a redemption gate limiting withdrawals to 5% of a fund’s net asset value. One important finding is that, across the modelled scenarios, most losses originate from the initial market shock rather than the subsequent forced sales. This suggests that, under the study’s assumptions, contagion through overlapping corporate bond holdings contributes relatively little to total losses compared with the direct impact of market declines. The distinction matters because liquidity management tools are primarily designed to address the additional pressures created by redemptions, rather than prevent losses arising from broader market movements.
Redemption fees and gates: Different protections, different costs
The research finds that redemption fees primarily change who bears the costs of liquidity. By charging investors who withdraw their money, these measures help protect those who remain invested. However, they produce only marginal reductions in total fund losses in the simulations. Redemption gates have a more pronounced effect under severe market stress. By restricting withdrawals, they can significantly reduce the need for forced asset sales and consequently limit total fund losses. But this protection comes at a substantial cost: investors lose access to liquidity precisely when they may need it most. The findings therefore highlight a fundamental trade-off between financial stability and investor protection. A measure that helps stabilise a fund may be disadvantageous for investors seeking to redeem. Conversely, allowing unrestricted withdrawals may expose remaining investors to greater costs and increase the risk of further market disruption. The report also finds that combining different liquidity management tools does not necessarily produce proportionately greater benefits. Without careful calibration, multiple measures may significantly restrict investor liquidity while delivering only limited additional reductions in fund losses.
Why governance matters as much as the tools themselves
The study argues against a uniform regulatory approach to liquidity management. Different funds have different investment strategies, portfolio liquidity profiles, investor bases and redemption arrangements. A mechanism that works effectively for one fund may be inappropriate for another. For this reason, the authors recommend that responsibility for selecting, calibrating and activating liquidity management tools should remain with asset managers, supported by appropriate supervisory oversight. Fund managers and boards should incorporate liquidity management into their broader risk frameworks, using stress testing to assess how different measures would perform under adverse conditions. Clear activation criteria, escalation procedures and investor communications are particularly important when restrictions on redemptions are involved. Transparency also plays a central role in maintaining confidence. Investors need to understand the circumstances in which access to their capital may be restricted and the potential consequences of those restrictions.
Managing liquidity without undermining investor confidence
The growing importance of nonbank financial institutions has brought investment fund liquidity under closer regulatory scrutiny. As investment funds play an increasingly significant role in capital markets, their ability to manage redemption pressures can have implications extending beyond individual portfolios. The CFA Institute research shows that liquidity management tools can contribute to financial stability, but their benefits must be assessed alongside their effects on investors. For investment professionals, the lesson is that effective liquidity management is not simply about minimising fund losses. It also requires determining how the costs of liquidity should be distributed between redeeming and remaining investors. The challenge is to design mechanisms that remain effective under stress without unnecessarily restricting access to capital or weakening investor confidence. Ultimately, the quality of liquidity management depends not on the number of tools available, but on the judgement, governance and transparency guiding their use.