Recent events have exposed some of the weaknesses of the open-ended fund structure
Investors trapped in gated funds are understanding for perhaps the first time the inherent risks involved in gaining exposure to illiquid assets via an Oeic, and realising that they are not the one-size-fits-all option that many took them for.
Oeics are certainly a straightforward way to gain exposure to a pool of diverse assets, and offer a host of benefits to investors.
However, when it comes to more illiquid holdings they have been revealed to be an unsuitable, even a high-risk option, for investors looking for exposure to alternative asset classes such as real estate and infrastructure.
Investor appetite for access to these illiquid assets has soared in recent years.
This has been prompted by the ‘hunt for yield’ in an age of rock-bottom interest rates and the whole-of-market investment approach adopted by IFAs following the Retail Distribution Review (RDR).
Attracted by high yields, more investors are diversifying their portfolios away from the traditional asset classes such as bonds and equities, and into alternative investments.
The pursuit of performance is a well-understood objective and a key push factor in the growth of alternative assets.
However, increasing interest in more esoteric asset classes means it has become all the more important to understand how to choose the best structure with which to gain exposure.
As we have witnessed over the past few years, traditional Oeics which invest in illiquid asset classes may have to resort to locking investors out of the fund when they struggle to raise cash to meet investor redemptions.
This is because it is far harder to sell, or ‘liquidate’, holdings in assets such as property, or infrastructure debt, quickly.
The alternative - holding large cash balances to satisfy investor redemptions - results in a ‘cash-drag’ on investment returns.
The closed-ended investment trust structure avoids the need for either of these approaches to the management of liquidity entirely.
There are basic differences between how investor supply and demand is managed in the two structures.
Open-ended funds satisfy investor demand by simply creating more units, and sellers are accommodated through the cancellation of units.
This can be disruptive for investment managers who need to be continually rebalancing the fund portfolio.
Such rebalancing is relatively simple for a deeply liquid portfolio of large cap equities as they are easily traded, and generally in demand, on public markets.
However, as gating and suspensions on open-ended funds have shown, rebalancing a portfolio comprised of less liquid assets presents its own challenges.
With the gating of property funds in the aftermath of the 2016 Brexit referendum, fund managers were faced with a hugely difficult choice.
Do they choose to dispose of properties to fund selling investors’ redemption requests?