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Retail investors who own alternative investment funds face possible liquidity risks, warns the European Securities and Markets Authority (ESMA) in a new report.

The regulator said that its latest review of the region’s 30,357 alternative investment funds found that the sector had a collective net asset value (NAV) of €5.8 trillion, which represents almost 40% of Europe’s fund industry.

The vast majority of alternative funds are sold to institutions (84%), but ESMA found that retail investor involvement “is significant at 16%,” and it noted the relationship between retail participation and liquidity risks.

“A detailed analysis of the liquidity risks of [alt funds] has highlighted that especially the categories with the highest percentage of retail investors are vulnerable to these risks,” said Steven Maijoor, chair of ESMA.

Retail investors accounted for 31% of the funds-of-funds category, and 21% of the real estate category, the report said.

“Many of the funds in the real estate sector offer daily liquidity, which indicates a structural vulnerability risk as they invest in illiquid assets while allowing investors to redeem their shares over a short time frame,” it said.

In the funds-of-funds sector, ESMA cited a liquidity mismatch concern.

In particular, it reported that 35% of the sector’s NAV is redeemable within a day, but that only 24% of funds’ assets can be liquidated daily.

The regulator also noted that hedge funds have increased their use of leverage.

“These funds are exposed to financing risk, as one-third of their financing is overnight,” the report said. “However, the fact that they maintain large cash buffers offers some security.”