Just how liquid are the funds your clients invest in?

The ECB president managed this feat with his repeated promise of balance-sheet expansion, something the Bank of Japan also unexpectedly did at the end of last month.

Such support – verbal or actual – usually creates a supportive background for equities. But if market movements in October are anything to go by, this should not make investors relaxed.

The savage volatility seems to have subsided – for now – which means it might be a good time to understand how liquid are the equity funds you invest in.

Now liquidity is a fluid phrase, if you’ll excuse the pun. While it broadly means the same thing to different people, it is hard to pinpoint an exact meaning. Yet it is something advisers should be monitoring.

So how do they do that? Former Skandia head of proposition Graham Bentley, who now runs his own consultancy firm gbi2, says there are several questions advisers can ask a fund manager to get a better idea of liquidity. In equity funds this is more pertinent for small cap funds, but it wouldn’t be bad to stress-test their large-cap cousins that have probably loaded up on stocks outside the FTSE 100 to help performance.

Now liquidity is a fluid phrase, if you’ll excuse the pun

Key questions seem to be how many securities have been in the fund in the past 12 months, as a fund that is more concentrated could be more sensitive to a market downturn. It is also worth asking, Mr Bentley suggests, the percentage of the portfolio typically held in cash – as this means redemptions can be dealt with quickly without resorting to a fire sale.

“Large buy orders on illiquid stocks distort the price,” Mr Bentley says. “Larger positions (eg in a fund with fewer holdings) are tougher to sell quickly.”

Mr Bentley believes a fund group’s compliance team should be able to estimate what proportion of the portfolio they can dispose of without affecting the price of underlying holdings. “You might like to think 50 per cent could be sold in 14 days, depending on the concentration of holdings,” he says.

It might also pay for advisers to find out the largest redemption experienced in a week by the fund and what would happen if the fund’s largest supporter withdrew its investment. “These are due diligence questions that every adviser should be asking if they do their own research,” Mr Bentley says.

It could make a difference to how your clients’ investments perform in the next shock.

It’s worth investigating now before we see another October, aptly described by Hove-based adviser Andy Merricks as a month “to have gone to bed on the first, drawn the curtains, watched the box set of The Sopranos, and re-emerged a calendar month later”.

Bradley Gerrard is news editor at Investment Adviser.