Real estate
iStockphoto/CHUNYIP WONG

Alternative investment funds that utilize leverage and face liquidity stresses pose potential investor protection and financial stability risks, the European Securities and Markets Authority (ESMA) warns.

According to a new report from the regulator examining the state of the alt funds sector, real estate funds in particular are potentially risky, given declining trading volumes and falling prices in several jurisdictions.

The liquidity mismatches that face alt funds generally are intensified by the high share of open-ended real estate funds, particularly those that offer daily liquidity, ESMA said: “These risks are material, especially in the fast-changing interest rate environment.”

Additionally, the liquidity risks posed by real estate funds “could be systemically relevant in jurisdictions where real estate funds own a large share of the real estate market,” it said, noting that these funds face risks related to leverage, liquidity, valuation and market footprint.

Hedge fund leverage also remains “very high,” ESMA said, adding that “this may pose a risk of market impact.”

However, most hedge funds also have cash to address potential margin calls, which limits the risk of fire sales.