UK experience a lesson in liquidity risk

Fund liquidity is one of the factors advisers should consider when placing their clients’ money, one researcher says.

Friday, July 12th 2019, 6:00AM 2 Comments

The issue of liquidity has been a focus of attention since British fund manager Neil Woodford's Equity Income Fund was frozen due to liquidity issues.

It had invested heavily in illiquid assets, which became a problem when a large number of investors wanted to withdraw their money because of perceived underperformance.

In New Zealand, the Financial Markets Conduct Act allows up to 20% of a managed fund to be in assets that cannot be sold at market value within 10 working days.

But some fund managers have more than that proportion in investments that would take longer than five days to sell.

Chris Douglas, a principal at My Fiduciary, said liquidity problems were difficult for a fund manager to recover from.

He said Woodford's fund has struck trouble in part because its investment style changed quite dramatically over time, from 40% small cap in 2015 to 95% small and microcap early this year.

That meant investors took on more liquidity risk than they might have realised.

If the market turned those investments could underperform "dramatically" and the trustees of a fund would have to act responsibly to limit redemptions.

It was something for advisers to check for, he said, although in New Zealand funds had tended to move from small cap focus to larger companies, rather than the other way around.

Advisers should understand the role funds were playing in a diversified portfolio and weight accordingly, Douglas said.

They should have systems to monitor investments quarterly to check for consistency of style and whether the composition of a fund's assets reflected the asset class it was selected for.

“Asking questions is really critical.”

Tags: Chris Douglas MyFiduciary

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Comments from our readers

On 12 July 2019 at 8:44 am smitty said:

finally, liquidity concerns are starting to seep through to our market. Let's hope it gets picked up, rather than this incessant focus on RI or fees. Maybe there should be a measurement of liquidity in addition to the lovely risk scale that the FMA put into place. It would certainly make people think about investing in 3 letter companies or more established NZ fund companies...

On 12 July 2019 at 11:12 am DavidBeattie said:

Liquidity risk and its ongoing management is a very important issue. However, the Financial Markets Conduct Regulations 2014 (not the FMCA 2013) state that, a managed investment scheme's products can be "offered on the basis that, in the ordinary course of business, the products will be continuously offered and redeemed on a basis calculated wholly or mainly on the value of the scheme property."

All KiwiSaver funds and most non-KiwiSaver managed funds are offered on this basis and there is therefore no legal minimum liquidity requirement.

The 80% min ONLY applies where a managed fund is NOT continuously offered.

Notwithstanding this and given how important liquidity is, making liquidity ratio information more readily accessible to advisers and investors is essential.

Currently it is buried deep in the Disclose Register - at least adding it to the Quarterly Fund Updates would be a start.

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