30 Jan 2020
There's no shortage of knowledge at RSMR! Each week we get our heads together and talk about events in the world and how investments are affected by them. Our broadcast tackles a wide range of topical issues facing investors from liquidity to the future of alternatives to politics and the pound. We like to think of it as cracking content for the financial adviser. Have a read & get clued up...
In recent months liquidity has been a hot topic, prompting us to dedicate this week’s broadcast to the potential risks and the future of illiquid assets.
What is liquidity? The definition of liquidity is ‘the availability of liquid assets to a market or company’. In other words, the ability to trade an asset easily, at low cost, without it affecting the price.
The suspension of the Woodford Equity Income fund and the M&G Property fund has cast a light on the issue of liquidity and the mismatch between the frequency with which some funds offer redemptions and the time it takes them to liquidate their assets.
The issue for open ended fund investors is that these less liquid holdings are not always obvious to the end investor. Under normal circumstances, investors can redeem assets relatively easily but in times of market stress this ability is reduced as there can be more sellers than buyers.
Illiquidity cannot be predicted as it can affect a wide variety of asset classes in different ways, depending on the particular event that has caused it. There are of course certain asset classes that can be seen to be less liquid such as unlisted stocks, non-investment grade bonds or property, but is it extremely difficult to exclude them from the average diversified portfolio.
Shares in large, quoted companies such as Apple, can be bought and sold with a high level of fluidity and with pricing transparency. However, illiquidity may be an issue for shares in smaller, unquoted companies as buyers may not be as readily available. Property funds can also be problematic as the assets can’t be sold quickly when sentiment goes against the market, leading to insufficient cash levels to meet demand and to the potential suspension of a fund.
Corporate bonds are another asset class where illiquidity has had a negative impact. A corporate bond market trades corporate debt rather than equity. A large company may want to raise a substantial amount of money and one way of achieving this is to issue bonds. Since the global financial crisis, there has been significant withdrawal of liquidity from the bond market due to the closure of investment bank proprietary trading desks. Instead of there being a two-way wholesaler, there is now just a middle-market agent, which has had an impact on asset prices.
Investors should not be put off investing in open ended funds because of the recent focus on liquidity issues. Our industry just needs to make sure clients are fully informed of the risks involved.
At RSMR, we question fund managers about how they manage liquidity within their fund and are conscious of fund flows. Following Woodford, the average investor is now much more informed about potential liquidity issues, highlighting the need for careful consideration of illiquid assets.
The FCA has confirmed new rules to protect investors, particularly during stressed market conditions, including requirements that open-ended funds that invest in illiquid assets must suspend dealing when ‘there is material uncertainty regarding the value’ of more than 20% of assets.
Christopher Woolard, Executive Director of strategy and competition at the FCA, said: ‘We want people to continue to be able to invest in illiquid assets through open-ended funds but it is important that they are appropriately protected’.
Some illiquid assets can produce favourable returns in the longer-term but monitoring and an awareness of the issues around liquidity are essential to protect your investment.
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This information is for UK Professional Advisers only and should not be given to retail clients.The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.
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