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Micro vs Macro Stress Test in the Investment Fund Industry


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The significant growth experienced by the investment fund industry over the last decade has heightened the relevance of this sector from a systemic risk viewpoint. The liquidity transformation activity undertaken by investment funds can potentially expose investment funds to financing risks, these being largely dependent on the liquidity of the investment fund portfolio.  The liquidity mismatch, which occurs when an investment fund does not have sufficient liquid assets to meet redemptions from investors, poses risks to financial stability since it could amplify and spread financial or economic shocks, creating contagion effects.

The Financial Stability function at the MFSA, in 2019 developed a Liquidity Stress Testing for Investment Funds Framework (STIFF) which is applied both at micro and macro levels for a sample of 64 Maltese retail investment funds. The micro-level stress test is based on a pure redemption shock. Its main aim is to assess the resilience of the individual investment funds to extreme weekly redemption shocks, which, in turn, may have an adverse impact on fund liquidity. The macro-level stress test is a scenario-based approach and is used to secure a better understanding of how the macro-economic environment can affect the liquidity profile of the Maltese retail fund industry and identify the types of funds that are most exposed to macro-economic shocks.

From the micro-level stress test, it emerged that only one fund out of a sample of 64 Maltese retail funds failed the stress test under the three different extreme redemption scenarios simulated, the 10%, 5% , and 1% worst-case scenarios, and under two liquidation approaches, the waterfall approach and the slicing approach. Another two funds failed the stress test under the 1% worst-case scenario, with one of these funds failing only under the slicing liquidation approach. Moreover, in most of the cases, the possible asset realisation losses incurred by those funds which experience a liquidity shortfall are below 5% of their Net Asset Value (NAV). Finally, the second-round redemptions and the magnitude of liquidation costs appear to be contained.

The macro-level stress testing was carried out at an investment strategy level. From the analysis, it emerged that funds classified as “other” and mixed funds are the most sensitive to an unanticipated shock in the macro-economic environment since they present the larger fluctuations in the expected net subscription or redemption levels. In general, the shocks that would, according to the MFSA study,  mostly affect the Maltese retail funds are a sharp decrease in the US interest rates, a sharp tightening in the money supply in Malta, and a spike in the unemployment rate in the Eurozone. Finally, most of the Maltese retail fund strategies hold a cash buffer well above the worst scenario generated, and thus such funds seem to be generally well poised to withstand shocks in the macro-economic environment.

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Regulator Information

Abbreviation: MFSA
Jurisdiction: Malta

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