FCA Reviews Open Ended Funds with Illiquid Assets

This blog gives you the latest topical news plus some informal comments on them from ShareSoc’s directors and other contributors. These are the personal comments of the authors and not necessarily the considered views of ShareSoc. The writers may hold shares in the companies mentioned. You can add your own comments on the blog posts, but note that ShareSoc reserves the right to remove or edit comments where they are inappropriate or defamatory.

The Financial Conduct Authority (FCA) is reviewing open ended funds that invest in such illiquid assets as property and infrastructure. It also potentially affects investments in private equity, unlisted securities and special purpose vehicles. If you recall, only a few months ago a number of property funds had to close to redemptions, i.e. investors could not get their money back, simply because of a minor panic over the impact of the Brexit Referendum vote. Although such funds do keep a cash buffer to cover day to day liquidity and can also adjust prices to deter redemptions, it seems this was not enough. The closures were mostly temporary but it highlighted the difficulties such funds can face.

The FCA have published a paper that covers the complex issues around this topic, and makes some suggestions to solve the problem (other than simply banning such funds). One is that “professional” investors might be treated differently to “retail” investors, i.e. there would be two classes of investors in the same fund. The principle behind this is that some investors might be more tolerant of short term fluctuations in fund values than others – for example retail pension investors may have a longer term horizon. How that would be reflected in the different treatment of multiple share classes is not clear.

Bearing in mind that only recently ShareSoc said to the FCA in a consultation response on their “mission” that we objected to “an artificial distinction drawn between wholesale and retail markets which does not and should not exist”. In other words, we would like all investors to be treated the same and there should be no prejudice against any one class, so it is unlikely we would support that proposal.

The FCA suggests a number of tools that fund managers could use to manage liquidity, or to warn investors about the risks of such funds. But why not simply ban them when there are alternative closed-end funds that provide exactly the same investment service – namely investment trusts? Such trusts do not have liquidity problems because they do not need to sell assets to meet redemptions (and it is the need to sell immovable assets in “fire sales” that cause the problem). Investors can sell their shares in the market at any time in investment trusts if they so wish.

It would seem that yet again the FCA is favouring the support of the institutions who manage open ended funds and profit from them, rather than those who invest in them, particularly retail investors. The latter often get advised to buy open-ended funds by IFAs and platform operators without being warned of the dangers they embody.

To read more go here: https://www.fca.org.uk/publications/discussion-papers/illiquid-assets-open-ended-investment-funds

If you have views on this matter, let ShareSoc know as we will be submitting a response to this consultation.

Roger Lawson

  1. Robert Morfee says:

    Open ended funds have advantages which investment trusts do not. The managers are regulated, you can always exit the fund at market value (subject, of course to liquidity) as there is no discount or premium to market value, and the fund is not liable to be loaded with debt. Moreover IFAs are expected to treat unit trusts as less risky as shares when advising clients. So open ended funds are much more numerous than investment trusts.

    Having said that there can be liquidity problems, and open ended funds tend to under perform investment trusts.

    I don’t think abolition is the answer. Investors simply have to realise that redemption can be deferred. The key problem in my experience is that IFAs have not, historically, come clean with investors about liquidity.

    Robert Morfee

    • sharesoc says:

      Investment trusts are of course regulated also, and the problem with open-ended funds investing in illiquid assets is that you cannot “always exit the fund at market value” as you put it.

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