Gridlex, a risk-management and trade analytics service, announced the launch Tuesday of a service evaluating the illiquidity of municipal bond mutual fund holdings.

The company is working with financial advisers, including Morgan Stanley’s private wealth business, to assess which funds have exposure to bonds that would be difficult to sell without taking a loss.

Mutual funds own $473.3 billion of state and local government debt, and tax-free money market funds own $324.4 billion, according to the Investment ­Company Institute.

With mutual funds scrambling to raise money to meet redemptions in December and early January, the ease with they could convert their holdings to cash has become more topical.

Mutual funds have reported $31.19 billion of outflows the past 11 weeks, according to Lipper FMI, breaking records in virtually every important category.

On the back of the outflows, funds had to sell bonds. A Bloomberg LP index measuring institutional bids-wanted surged to $1.4 billion in December.

Much of that was due to mutual fund complexes trying to raise cash, according to traders.

More so than most corporate bond sectors, municipal bonds can be difficult to sell.

Gridlex’s analytics looks at mutual fund holdings and utilize two factors to gauge their liquidity: the percentage of bonds in a portfolio that haven’t traded in the past 90 days, and the “time to liquidity,” which measures how long it would take to liquidate a position based on the underlying bonds’ trading frequency.

These are closely related metrics, since a primary driver of time to liquidity is how many bonds in the portfolio don’t trade.

Gridlex found that the fund suffering from the worst liquidity at the end of 2010 was the Dupree Kentucky Tax-Free fund, which held 73.3% of its portfolio in bonds that had not traded in the last 90 days. The Thornburg Intermediate Municipal Fund finished second, with 70% of its assets in infrequently traded bonds.

These metrics are important because a fund forced to sell bonds will presumably take a bigger haircut for illiquid bonds.

Nikhilesh Rao, founder and chief executive officer of Gridlex, argues that shareholders of mutual funds with illiquid bonds are not compensated for the additional risk they take.

Gridlex analyzed returns of ­municipal funds with relatively liquid holdings versus illiquid funds, and did not find a correlation between illiquidity and returns.

Register or login for access to this item and much more

All On Wall Street content is archived after seven days.

Community members receive:
  • All recent and archived articles
  • Conference offers and updates
  • A full menu of enewsletter options
  • Web seminars, white papers, ebooks

Don't have an account? Register for Free Unlimited Access