Concentration risk grows for UK funds

The concerns have come following Majedie Asset Management’s proposal to remove the stock limit on its UK Income fund.

The investment policy for the £1bn vehicle, run by Chris Reid, states it is “likely to have a relatively concentrated portfolio of approximately 40-60 holdings at any given time”.

However, the board has proposed to remove this sentence, saying it is “unduly restrictive”.

Majedie’s fund has grown rapidly in recent months, attracting roughly £500m in net assets in the past year.

Lee Robertson, chief executive of boutique wealth management firm Investment Quorum, said: “Everyone’s choosing the same funds for the same reasons, so capacity is a real issue. This means that liquidity becomes a problem.

“I suspect managers are worried and must be looking at [greater flexibility on the number of holdings] because they are just being constrained by their original mandates.”

Equity income funds are more constrained than their growth counterparts, because the pool of stocks from which they can choose is a degree smaller.

This can also mean income funds are more concentrated.

Of the UK equity portfolios that have more than £1bn in assets, the median number of holdings for a growth fund is 63, but this falls to 52 for UK equity income funds, according to Investment Adviser analysis.

Majedie’s circular to shareholders said: “As the strategy has grown in size, it is considered that the flexibility to have more holdings is needed.

“Unlike many UK income funds that invest predominantly in the largest UK companies, the fund has a number of holdings in medium-sized firms.”

The board added that the flexibility was needed to “ensure the illiquidity risk of the strategy does not increase beyond where it has been historically”.

Majedie added: “Illiquidity risk arises from owning a larger percentage of the share capital of particular companies, which can make it more difficult to sell the holding at a good price.

“Otherwise the fund might be forced to invest more in large-cap stocks.”

Mr Robertson said managers seeking a larger number of holdings, in both the equity and the bond space, might have to find other ways of expanding their funds to overcome the issue.

“People are going to have to go outside the traditional jurisdiction,” he said.

“UK investors are UK-centric, but they may have to go down the global equity income route. That may come with issues such as currency risk.”

Brewin Dolphin fund analyst Tom Jemmett said: “If you have a mid-cap-focused fund doubling in size in six months from an already large starting point, the chances are you’re going to run into liquidity problems.

“[This] issue is likely to be exacerbated by a predefined, focused number of stocks.”

City Asset Management research director James Calder argued some solutions could circumvent the problem.

He said: “It should not be an issue if they are longer-term investors. Liquidity risk is an issue, but this is more of a concern for bond managers and smaller company managers.

“There are some solutions – managers are using dark pools to cut out the investment bank and trade with each other.”