The redemption coverage ratio sets the liquidity a fund can raise by each payment date against what investors can ask for by then, and it shows which liquidity tool actually closes a gap.
The redemption coverage ratio is the cash a fund can raise by a payment date, after stress haircuts, divided by the redemptions it could face by that date. For an illustrative 500 million open-ended credit fund, assets worth 23.43 per cent of NAV can be turned into cash within a quarter against stressed redemptions of 22 per cent: a ratio of 1.06. In a severe quarter of 30 per cent redemptions it falls to 0.78, and the choice of liquidity tool decides how that gap closes.
Worked in full in The AIFMD II Handbook by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A liquidity stress test produces a lot of numbers; the coverage ratio turns them into one per horizon that a board can read. It is the asset side of the Annex IV liquidity profile set against the liability side, with the stress put on both. Under AIFMD II, where open-ended funds must select at least two liquidity management tools from the directive's list, it is also the quickest way to see which tool does any work.
| Asset bucket | Days to cash | Share of NAV | Million | Stress haircut | Cash raised, % of NAV |
|---|---|---|---|---|---|
| Cash and money market funds | 0 | 4% | 20.0 | 0% | 4.00 |
| Liquid bonds and syndicated loans | 7 | 6% | 30.0 | 2% | 5.88 |
| Loans saleable within a month | 30 | 5% | 25.0 | 5% | 4.75 |
| Loans saleable within a quarter | 90 | 10% | 50.0 | 12% | 8.80 |
| Loans saleable within six months | 180 | 15% | 75.0 | 15% | 12.75 |
| Originated loans held to maturity | n/a | 60% | 300.0 | not sold | 0 |
Redemption stress: in the first month the two largest investors, 12 per cent of NAV between them, leave; in each of the next two months redemptions match the worst month on record, 5 per cent. That makes 22 per cent over the quarter. A severe scenario takes 30 per cent in the quarter.
RCR(h) = Σ share of bucket × (1 − haircut), for buckets liquid within h ÷ stressed redemptions payable within h
In Excel, with days in B2:B6, shares in C2:C6, haircuts in D2:D6 for the saleable buckets and the horizon in days in G1: =SUMPRODUCT((B2:B6<=G1)*C2:C6*(1-D2:D6))/G2, with the stressed redemptions for that horizon in G2.
Step 1: one month. Cash 4.00, liquid bonds 6 × 0.98 = 5.88, the one-month loans 5 × 0.95 = 4.75: 14.63 per cent of NAV, 73.1 million. Stressed redemptions are 12 per cent, 60.0 million. RCR = 14.63 ÷ 12 = 1.22.
Step 2: one quarter. Add the quarter bucket at 10 × 0.88 = 8.80: 23.43 per cent, 117.2 million. Redemptions are 12 + 5 + 5 = 22 per cent, 110.0 million. RCR = 23.43 ÷ 22 = 1.06.
Step 3: the severe quarter. 23.43 ÷ 30 = 0.78. The shortfall is 6.57 per cent of NAV, 32.8 million, which would have to come from the six-month bucket at whatever price a buyer offers within the quarter.
| Case | Month | Quarter | Severe quarter |
|---|---|---|---|
| No tool | 1.22 | 1.06 | 0.78 |
| Gate at 5% of NAV per dealing date | 2.93 | 1.56 | 1.56 |
| 90-day notice period | 1.95 | 1.64 | 1.21 |
| Carrying values, no haircuts (the mistake) | 1.25 | 1.14 | 0.83 |
A ratio above 1.0 does not mean the fund is still liquid afterwards. Paying the quarter's 22 per cent from the most liquid assets first costs 1.38 points of NAV in haircuts and leaves NAV at 76.62 per cent of where it started, 383.1 million. Of the 25 per cent of the portfolio that was saleable within a quarter, only 2.1 per cent of the new NAV remains, and originated loans held to maturity are now 78.3 per cent of the fund. The next quarter's ratio is close to zero. A stress test that runs one quarter and stops reports the first round as if it were the last.
All figures are illustrative. Haircuts and redemption scenarios are the manager's own assumptions and should be calibrated and back-tested, not copied from this example.
The book's own stress test for a semi-liquid credit fund, with the facility and the undrawn commitments computed line by line, is in the free workbook for this case.
Above 1.0 at every horizon in the stress scenarios the manager has chosen, with a margin for model error. A ratio of 1.06, as in this fund's quarter, means the liquid assets cover stressed redemptions with 1.43 points of NAV to spare, which a slightly worse haircut would erase. Below 1.0, the fund cannot pay without selling assets it has not classified as saleable.
AIFMD requires managers of open-ended AIFs to stress test liquidity and align the redemption policy with the portfolio, and ESMA's guidelines on liquidity stress testing describe coverage of redemptions as one way to read the results. The ratio itself is a method, not a prescribed formula, so the file should state its horizons, haircuts and redemption scenarios.
It caps the denominator. With a gate at 5 per cent of NAV per monthly dealing date, the most investors can take in a quarter is 15 per cent, so the quarter's ratio moves from 1.06 to 1.56 and the severe 30 per cent run can no longer happen in one quarter. The gate defers redemptions; it does not create liquidity.
This article is one calculation from The AIFMD II Handbook. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
Get the book on Amazon →Free companion files
Also on Amazon UK · Amazon Germany · Amazon France · Amazon Canada
Reading guide: regulation, compliance and banking → · All 1340 articles →
If this book helped, or didn’t, a few lines on Amazon are worth more than they look: they are what the next reader goes on. Write a review. The workbook stays free either way.