Once again, the liquidity of daily dealt funds has made headline news.
Back in June 2019, Neil Woodford’s flagship fund, the Woodford Equity Income Fund, stopped taking redemption requests and will now be wound up, which has prevented 300,000 investors from accessing their investments.
More recently, in December 2019, M&G suspended dealing on its £2.5bn property fund due to £1bn of redemptions in a 12 month period, and the difficulty the firm has had in selling assets to meet all of its redemption requests.
These high profile cases highlight the problem of liquidity mismatch. Both funds offered daily dealing, which enables investors to buy and sell units in the fund each day. However, as the underlying assets cannot be sold at such quick pace, the funds were forced to suspend redemptions while assets were liquidated to meet the withdrawals.
One issue with the M&G property fund is that it had a high retail investor base. This class of investors has historically been quick to move money around at the slightest hint of ‘trouble’. Normally, defined benefit pension schemes will invest into ‘institutional only’ property funds, which makes redemption requests more stable and the funds less likely to be suspended.
The Bank of England (BoE) has said that the issue of liquidity mismatch has the potential to become a systemic risk – this highlights the seriousness of the issue. This risk being realised would potentially see similar funds suspended; this contagion effect was reflected following the M&G announcement, as investors started selling other property funds.
To combat the issue of liquidity mismatch and to protect investors, the BoE and the Financial Conduct Authority (FCA) are considering making daily redemptions of property funds incur a financial penalty. This is aimed at preventing large withdrawals and aligning redemption periods with the length of time it takes to sell underlying assets at a fair price.
In September 2019, the FCA announced new rules requiring property funds to suspend dealing if there is uncertainty over the value of 20% of their assets. This may see more property funds being suspended, which could damage investor confidence in the asset class and discourage investors from allocating to open-end property funds. Fund managers will likely respond to the new rules by holding a high cash balance, which will result in lower returns.
It is encouraging that both the BoE and the FCA recognise the importance of liquidity. In my view, the measures may create additional risks and potentially sacrifice returns, however, liquidity mismatch is a serious issue for investors and I am glad more efforts are being made to stop it.