LONDON (Reuters) - Europe's securities watchdog said on Wednesday it was monitoring the funds industry for sources of future market vulnerabilities.
The European Securities and Markets Authority (ESMA) said it was looking at issues such as fund investments in loans, so-called "smart beta" products, as well as possible systemic risk in the hedge fund industry.
ESMA said the growth of funds investing in loans was "one of the most consistent trends in the EU fund industry", and while it offered diversification to fund managers, it also created credit and liquidity risk.
While funds that originate loans could boost lending to small and medium-sized companies, there was risk of financial instability that would need to be addressed by "harmonised and adequate macro and micro-prudential supervision".
Smart-beta products, meanwhile, could expose investors to other risks, such as sector volatility, and were often opaque, with a low level of transparency which made it hard for investors to understand their risk-return profile.
"ESMA's report therefore sees that the main risks are related to the limited transparency of their constituents, weights, methodology and simulated past performance," it said in a statement.
Reporting by Simon Jessop; Editing by Mark Potter