OREANDA-NEWS. Fitch Ratings says funds face growing capacity issues due to the combined effect of reduced overall market liquidity, growth of a fund's AUM relative to supply, fund flow concentration and search for return reaching into less liquid asset classes.

Capacity issues are becoming particularly pressing in the credit fund sector, where these trends have been most pronounced. In addition, we consider the safeguards and techniques of blockbuster credit funds, against fire sales during a sustained period of heavy outflows in illiquid markets, untried.

Nevertheless, the largest funds in capacity-constrained categories have overall maintained or improved their three-year performance record relative to peers and their benchmarks since 2012, supporting the idea that most of the largest funds have not reached the point of maximum capacity despite strong AUM growth over the period.

The ability of active asset managers to exploit market inefficiencies reduces as fund size increases. Beyond a certain limit, "capacity", a fund's ability to outperform its peers and objectives may be constrained.

Fitch considers that a fund's size directly influences sources of returns, but affects returns themselves only indirectly. Size has an effect on the implementation of investment strategy, which may affect the consistency of performance.

We believe capacity management can be a source of investment edge, which may be better revealed in prolonged periods of outflows and market sell-off.