The liquidity of investment funds has come into sharp focus in recent weeks, following the trading suspension imposed on investors in the Woodford Equity Income fund. The fund, which reportedly had 85% of its assets invested in illiquid stocks, has been the cause of much debate.
The Bank of England governor, Mark Carney, has now thrown his weight behind criticism of the fund, explaining that such funds are “built on a lie.” His comments refer to the inclusion of illiquid assets in funds which supposedly allow investors instant access to their money.
It’s not the first time easy to trade open-ended investment funds holding hard to trade assets have come under fire. In the wake of the 2016 Brexit referendum, some open-ended property investment funds had to place trading restrictions on investors, as they were unable to sell assets fast enough to meet redemption requests.
Carney told MPs, “These funds are built on a lie, which is you can have daily liquidity.”
Where investment fund assets “fundamentally aren’t liquid”, said Carney, or could become illiquid during a market downturn, that “lie” could lead to market instability, as it results in investors expecting the same kind of access to their money as they might expect from a bank account. Carney explained to MPs that investors should expect terms in line with the liquidity of the assets, and therefore not assume instant access should they wish to sell their holdings. He said, “We do have to be very deliberate about the types of measures that need to be taken — something that better aligns the redemption terms with the actual liquidity of the underlying investment is infinitely preferable to the situation we have today.”
While his comments were not aimed explicitly at Neil Woodford, they came only a day after Financial Conduct Authority chief executive Andrew Bailey alleged the Woodford fund had exploited regulations “to the full” and had been “sailing close to the wind” when it came to its holdings in illiquid assets.
European rules for investments, known as Ucits, say that investment funds with daily dealing must hold no more than 10% of assets in illiquid assets, such as unquoted stocks.
The FCA chief revealed this week that only two UK investment funds, out of a total of around 3,000, had breached these Ucits rules on illiquid assets. One fund to breach the limit was Neil Woodford’s Equity Income fund, with the other an unnamed small fund.
When selecting suitable investments, matching the liquidity of underlying assets with your requirements to access the money is an important consideration.
If you decide to invest in illiquid or hard to trade assets, then a closed-ended fund structure, typically an investment trust, could be better suited than the open-ended funds which have a liquidity mismatch.
Sensible investing means taking risks worth taking and at Wells Gibson we advocate taking risks supported by evidence.