The lowdown on fund liquidity and why it matters

DIY Investor Toolkit: Fund liquidity has gained greater prominence in recent months, we explain what it is and why it matters.

Fund liquidity has gained greater prominence in recent months, following the decision by Britain’s best-known fund manager Neil Woodford to block investors from withdrawing money from his main fund, LF Woodford Equity Income.

The latest news on the high-profile fund suspension is that LF Woodford Equity Income will remain closed until early December; the fear among industry commentators is that the debacle risks putting off prospective new investors, first, from investing in general but also from choosing an active fund manager.

But the reality is that such closures do not happen all that often. That is because most funds are ‘liquid’, so investors should not have any problems withdrawing their money. Liquidity is basically a fund’s access to liquid assets – cash, or those that can be quickly and easily converted to cash without losing value.

Most funds are highly diversified in holding a wide spread of investments that are listed on a stockmarket. Woodford made problems for himself down the line by having too many investments that are unquoted – not listed on any stockmarket. Unquoted shares are difficult to sell quickly at the best of times, so when there is a sudden rush of fund investors asking for their money back at the same time such requests cannot be facilitated unless sales are forced through, which runs the risk of the investments being sold for notably less than they are worth. At such times, a fund suspension is put in pace to protect those investors remaining in the fund.

On the whole the only funds to be wary of as potentially having a liquidity problem are those that predominately invest in illiquid investments – with property being the prime example. In normal market conditions, although it takes months for these commercial property funds to buy and sell the shops, offices and factories that are held in the portfolios, it is not a problem for investors to withdraw their cash on a daily basis, as a portion of the portfolio remains in cash, typically 10% to 20%.

But, during times of heavy selling it is a different story, as the cash buffer is depleted – which in turn makes it difficult for open-ended commercial property funds to meet withdrawals on a day-to-day basis. This is because property sales are not quickly or easily arranged, particularly in times of market uncertainty. It is therefore very difficult to raise money quickly.

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