ICI Chief Economist Criticizes SEC's Method of Measuring Mutual Fund Liquidity

Investment Company Institute ("ICI") Chief Economist Brian Reid, author of one component of the ICI's multipart response to the SEC’s liquidity risk management proposal and the SEC’s Division of Economic and Risk Analysis’ ("DERA") study, Liquidity and Flows of U.S. Mutual Funds, explained one unintended consequence of the SEC’s six-bucket liquidity classification scheme: incorrect fund liquidity assessments.

In a blog post, Mr. Reid argued that the SEC’s liquidity proposal will push fund managers to rely on third-party vendors using models based on backward-looking, quantifiable inputs to classify the liquidity of their managed securities. While Mr. Reid noted that the ICI supports the goals of the SEC’s proposal to improve funds’ abilities to meet redemption requests, the ICI’s view is that liquidity classification is significantly more complex than the SEC’s six bucket approach. Mr. Reid asserted that classifying a fund’s securities into such buckets will be onerous for fund managers and could even provide investors with an inaccurate view of certain funds’ liquidity based on ineffectual assumptions and inputs. For example, he explained, a standard S&P 500 index fund could be viewed as illiquid under the six-bucket classification because indicators of liquidity, such as average daily trading volumes, could lead to different liquidity profiles for large and small funds with similar liquidity management approaches. Mr. Reid stressed that if such incorrect liquidity classifications are relied upon by investors, such classification could actually compound liquidity risk in the market.