Investments  

Focus on liquidity has increased

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Guide to closed-ended vs open-ended funds

Focus on liquidity has increased

Liquidity has become a big issue in recent times.

Following the EU referendum in 2016, a number of open-ended property funds had to suspend trading for a period of time due to a high number of investors seeking to redeem their holdings.

Similarly, the Woodford Equity Income fund debacle has highlighted how illiquid investments can cause problems for the dealings of funds.

Embattled fund manager Neil Woodford was forced to suspend his Equity Income fund on June 3 after investors pulled around £9m per working day from the fund in May.

The ratio of illiquid and unquoted holdings within the fund prior to its suspension has come under scrutiny as it emerged the fund had broken its 10 per cent permissible threshold twice prior to its suspension.

Liquidity

Scott Gallagher director at Rowley Turton says: “Poor liquidity meant that people couldn’t get their money out as quickly as they wanted and is one of the reasons you should have a diversified portfolio not entirely reliant on any one fund.”

If an investor has an open-ended structure that has a mixture of liquid and illiquid assets, and then the underlying unit holders redeem, inevitably they will only be able to sell liquid assets into the market.

And over time if there continues to be a prolonged series of redemption within the fund, it means that the illiquid assets make up a greater proportion of the portfolio.

For example, in a £100m open-ended fund,£20m is invested in illiquid assets and 80 per cent is invested in liquid assets.

If 40 per cent of the fund is redeemed, the £100m will not be a £60m fund, so the 20 per cent allocation to illiquid assets increases.

Steven Lloyd, Investment Director at Ascot Lloyd says: “If everything is operating ‘normally’ then open ended fund managers are able to sell assets quickly enough to meet investors’ demand for redemptions - they have enough ‘liquidity’.

“However, when open ended funds invest in physical property there can be a ‘mismatch’ when there is a shortage of asset sales to meet redemption

“If this is the case then the fund manager can 'gate' the fund. This is when they didn’t allow investors to withdraw their money. 

“This is exactly what happened with the Woodford Equity Income fund when the investments could not be sold quickly enough to meet consumer demand for money.

"This has brought the liquidity of open ended funds to the forefront of investors’ minds.”

As a result, closed-ended funds are seen as more suited to illiquid assets.

Closed-ended funds are much better vehicles for illiquid assets because the fund and the fund manager can stand aside from the disruptive shorter-term demands of selling those illiquid assets to repay those unit holders who want to exit the fund.