PropertyFeb 13 2017

Observers wary of FCA illiquid fund rethink

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Observers wary of FCA illiquid fund rethink

Possible reforms that would redefine how wealth managers and other intermediaries are classified when investing in illiquid funds risk creating a double standard for investors, according to industry commentators.

The FCA, in a paper produced in response to last summer’s property fund suspensions, has invited comment on a number of ideas to improve liquidity management. These include making funds hold certain levels of cash, or providing more guidance to asset managers on anti-dilution measures and other tools.

But it is the suggestion that “retail” and “professional” investor assets could be divided more strictly that would represent the most significant change to current practices – not least because of the way the regulator has defined the two terms.

An FCA spokesman told Investment Adviser that “retail” investors meant those who were self-directed, with “professional” investors representing the likes of wealth managers as well as institutional investors.

Jake Moeller, head of UK and Ireland research at Thomson Reuters Lipper, said placing retail and professional investors in separate funds would “run the likelihood of higher-quality assets being in one pool as opposed to another”. 

“There is a risk of moral hazard being created by a fund manager pushing a particular type of asset onto one type of investor.” 

More sophisticated than retail investors, and more likely to tactically reallocate than institutional investors such as pension funds, wealth managers and funds of funds were among those who reacted most quickly in the 10 days between the EU referendum vote and the first fund suspensions. 

This suggests the impulse behind the FCA’s concept of categorising these investors separately from self-directed investors has some merit. An alternative to separate funds could be to use separate share classes with differing redemption terms, the regulator suggested.

But this, too, would represent a radical shift. Most asset managers do offer separate retail and institutional share classes for their portfolios, but wealth manager monies are usually placed in the former.

“[Different] share classes would be an option – but if you made property funds non-daily dealing that would deter people looking for more liquid investments. A lot of DFM mandates [wouldn’t] invest,” said Rob Gleeson, head of research at FE.

Some emphasised the principal issue remained the disconnect between illiquid assets and open-ended funds offering daily dealing. 

“Besides the fact all clients need to be treated equally, conceptually, in the end, the problem is intrinsic to the offering,” said Fundhouse managing director Rory Maguire.

But Darius McDermott, managing director of FundCalibre, said relatively swift reopening of suspended funds in both 2016 and during the financial crisis in 2008 represented a “pretty good argument” in favour of continuing to allow open-ended funds to invest in property.

The FCA said it had “doubts” over the idea of preventing funds invested in illiquid assets from offering daily dealing, saying changes “could simply result in an accumulation of…orders to be executed at a single point”. It also ruled out banning retail investors from accessing open-ended property funds.

One idea that was broadly welcomed was that of ensuring fund firms cap the amount of a portfolio that can be held by an individual investor or business.

“It makes sense for funds that have a large multi-manager or private wealth manager interest. It is as much an obligation for asset managers as it is for wealth managers,” Mr McDermott said.

The FCA is inviting feedback until May 8. It will publish a consultation paper later in the year should it propose new or amended rules.

Additional reporting by Dave Baxter

 

Possible changes for ‘professional investors’

• Prevent the investment of both retail and professional investors’ monies in the same fund.

• Use separate share classes for the two groups rather than, for example, restructuring existing funds.

• Require the manager of a fund holding illiquid assets to manage the diversity of its investor base more actively, to prevent one investor or group acquiring more than a set proportion of assets.

• Challenge fund managers who do not make sufficient use of current rules that give them the power to gather information about underlying investors – though this is complicated by the rise of platforms.

• Regulator also open to other options.