It’s not enough that mutual fund managers (and their ETF counterparts) must find good securities to buy. Now they must be able to say how easy it is for their holdings to be traded for cold hard cash.

According to a Securities and Exchange Commission liquidity rule coming into effect this year, fund managers must put all stocks, bonds, real estate, derivatives and whatever else into one of four liquidity buckets, from the most liquid to the driest—the last being where you might move the price of a security by the very act of buying or selling it.

The rule is SEC 22e-4. And for some managers it’s become a nightmare to contend with.

While it’s not much of an issue for those who trade high-volume S&P 500 shares, portfolio managers worry that it’s going to cause a problem for small-cap managers and bond traders and holders of other securities in those cases when just wanting or not wanting something can change its price.

“For us and other mutual fund managers, it’s driving us crazy,” said George Young, a partner and portfolio manager at Villere & Co., when talking about the rule. Villere manages some $2 billion in equity and fixed-income strategies for separate accounts and mutual funds. “We have to assign a certain liquidity risk value to each of the different holdings, stocks and bonds, in our portfolio,” Young said. “And for stocks to a certain degree, it’s relatively easy to do. But for bonds—and bond trading is just not as transparent as stock trading—that’s a real nightmare for us, to try and figure out how liquid is this particular bond.” It can greatly affect certain names he likes: say, the high-yield 2027 bonds from manufacturer H.B. Fuller, which has a 4% coupon.

“If it’s a Johnson & Johnson bond, there are a lot of bonds out there and there is a lot of appetite for those bonds. … Once you get into Fuller Brush territory, there’s not that much interest in those bonds and it’s a small issue. So that makes it a little more awkward to assign a specific value.” He said that in bonds, when there are specific issues that a fund manager needs to fill out a portfolio, the desire for a security is going to move its price, unlike a hunger for, say, Apple shares.

The Buckets

Specifically, the new rule requires fund companies to put their holdings into liquidity buckets. The other requirement is to set up a liquidity risk management program and meet the new 15% limits on how much in illiquid securities a fund can hold.

The 15% limits and liquidity risk management program requirements have already gone into compliance for all funds, large and small. “All fund mangers should be aware of those and should already be complying with those,” said Gail Bernstein, general counsel at the Investment Adviser Association, a nonprofit that represents SEC-registered advisor firms.

The new rule staggered compliance dates for different requirements, sorting by fund size. Larger funds with $1 billion or more were required to set up a liquidity risk management program and meet the 15% illiquid security limit by December 2018. By the following June, the large funds had to have the liquidity classification, or bucket, system set up for their securities.

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