Annabel Brodie-Smith, director of communications at the AIC, told FTAdviser the concept of investing in illiquid assets through open-ended vehicles that offered daily dealing posed systemic risk to consumers.
Ms Brodie-Smith was discussing the “lessons to be learned” from the collapse of Woodford Investment Management after former star fund manager Neil Woodford was forced to suspend his flagship Equity Income fund in June.
The saga refreshed concerns about illiquid assets in open-ended funds. Mr Woodford had breached European rules which mean unlisted (typically more illiquid) securities can only make up a maximum of 10 per cent in open-ended funds twice at the start of 2018.
Ms Brodie-Smith said: “The key problem was the illiquid nature of the portfolio, meaning Woodford could not sell its investments fast enough to meet redemptions.
“We saw open-ended property funds face the same problems during the financial crisis and after the EU referendum when many funds were suspended.”
Property funds have also been gated in the past few months, with M&G Property Portfolio and Prudential’s linked portfolio shutting the doors to investors earlier this month.
She added: “We are most concerned by the threat of systemic risk and the need to protect investors.
“The fundamental problems with open-ended funds that invest in illiquid assets need to be addressed.”
Ms Brodie-Smith thought the best way to protect consumers was for funds to offer a ‘reliable redemption’ by matching their redemption terms to the reality of how long it would take for investors to redeem their money.
She said: “This could mean investors need to give notice to access their cash, but they would know from the outset what they were signing up for.”
Under this scenario, funds invested primarily in liquid stocks could offer daily dealing but those that choose more illiquid companies could offer varying pledges of how quickly investors could expect returns.
The AIC is contributing to the regulatory response to the Woodford saga and developing its ‘reliable redemption’ solution.
Earlier this month the Bank of England and Financial Conduct Authority floated proposals to curb the problems presented by illiquid assets in open-ended funds.
The regulators suggested investors pulling their cash should receive a price for their assets which reflected the discount needed to sell the required portion in the specified time period.
For example investors who asked for their assets within 24 hours would receive a lower price for their units compared to investors who gave a longer notice period.
This meant redeeming investors would bear the consequences of a potential discount rather than investors left in the fund.
But the AIC was "not convinced" by their suggestions, arguing investors would still be incentivised to leave the fund earlier before pressures became "acute" and claiming it would be extremely confusing for investors.
Ian Sayers, chief executive of the Association of Investment Companies, said: “These problems could be avoided by our proposal for ‘reliable redemption’.
"This would be much simpler to convey to investors and does not penalise them simply for wanting to leave the fund."
The Woodford Equity Income fund was suspended in June after Kent County Council asked to pull all of the £260m it had invested in the portfolio through its workplace pension.
The fund had been running with outflows averaging £9m per working day in May but Mr Woodford's representatives had played down fears about the fund's liquidity, saying outflows had become moderate and that the fund manager remained as confident as ever that his strategy would pay off.
But when Kent County Council’s request arrived the fund did not have enough liquidity to meet the redemptions and was suspended. This eventually led to the administrators' decision to wind down the fund and consumers are expected to lose at least 30 per cent of their investment.
imogen.tew@ft.com
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