The expanse of liquidity scandals coming out of the asset management industry should be a warning to investors. In less than a year, there have been at least three well-published events: GAM, Woodford and H20. Even the governor of the Bank of England, Mark Carney, has warned that daily dealt funds that are not liquid are “built on a lie” and if nothing is done they could pose a systemic problem.
With the increasingly difficult search for yield, fund managers are diving deeper into more illiquid assets. When investors in their daily dealt funds want their money back after a change in sentiment, some negative news or performance of a fund, a ‘fire sale’ can be triggered where investors want their money back immediately. In reality, this may not always be possible for some daily dealt and other funds with longer redemption periods. When a client wishes to redeem, the manager normally disinvests from holdings which are the most liquid and the cheapest to sell. When more and more investors redeem, the fund becomes more illiquid. Then investors panic as they do not want to be left with the illiquid assets resulting in many redemptions happening at once. This overloads the manager, who is unable to sell the underlying investments to meet the redemption requests and often they must suspend the fund to manage the sale of these assets.
Investors should understand their fund managers’ investment philosophies and have confidence in their portfolio management skills, in addition to seeing that they have a robust risk management team. Clients should be cautious of star managers who have too much influence over the risk management process. They should avoid making up a large portion of a fund as they may struggle to redeem even under normal circumstances. Investors should not be chasing yield without considering the risks carefully; whilst it’s frustrating that returns are low, having money tied up in an illiquid suspended fund would be even more so.
In July 2018, the Swiss asset manager GAM suspended leading bond manager Tim Haywood after a whistle-blower raised concerns about his conduct, namely breaching due diligence rules and company policies. This triggered a huge wave of redemptions and ultimately the closure of £8.5bn of fixed income funds. Subsequently, the GAM chief executive stepped down and the share price declined 70%. The main issue faced by investors was getting their money back as the funds had a lot of illiquid holdings which were hard to sell.
On 3 June 2019, the popular Woodford Equity Income Fund, managed by fallen star manager Neil Woodford, began to make mainstream headlines as dealing in the fund had been suspended. This was due to serious liquidity issues after continued mass outflows from consistently poor performance. According to MSCI, at the end of 2018, 85% of the fund’s net asset value invested was in illiquid securities, which creates a major issue around selling assets and returning clients’ capital.
The FCA is now investigating Woodford for breaching liquidity rules.
The most recent case study took place on 18 June. H2O Asset Management, a subsidiary of French group Natixis Investment Managers, was the subject of a Financial Times article detailing that the fund had bought some illiquid bonds linked to entrepreneur Lars Windhorst, who has a history of bankruptcy, various legal troubles and a suspended jail sentence. The CEO of H20 was appointed to the advisory board of a Windhorst company raising the appearance of a possible conflict of interest; he has since resigned, but needless to say this has triggered a wave of redemptions.
With $13 trillion of global fixed-income assets currently generating a negative yield, the temptation for fund managers to take more risk and move into more illiquid assets to generate higher yields is hard to resist. This means it is highly possible that more illiquidity scandals will happen. Mark Carney has called for increased regulations to ensure investors are not misled, and European regulators are designing new liquidity rules for funds, which will hopefully offer better protection for investors.