Vast majority of funds do not have Woodford’s liquidity problem

Data firm and index provider MSCI analysed whether 400 open-ended funds would fall foul of the same problems that prompted Neil Woodford to suspend Woodford Equity Income at the start of June.

The vast majority of open-ended funds would not run into the same problems that led Neil Woodford to bar investors from withdrawing their cash from his Woodford Equity Income fund at the start of June, according to new analysis.

MSCI, the data firm and index provider, analysed a sample of 400 funds sold to European investors, that have assets of more than €1 billion and primarily invest in shares.

The firm examined whether funds have a potential liquidity problem; to assess this they used US fund regulation rules, which do not allow funds to hold more than 15% in investments deemed illiquid.

Once the US rules were applied, MSCI found that just seven funds could in the future fall foul of the same liquidity problems if there were a sudden rush for the exits. It did not disclose the names of the funds.

Fund firms in the US are required to classify their investments into four liquidity buckets: highly liquid, moderate, less and illiquid. European fund rules state that no more than 10% of a fund’s net asset value can be held in illiquid assets.

In particular, one of the big differences between the two rules is that shares in a small-sized listed company may be put in the illiquid bucket under US regulations, but under European fund rules only unquoted shares would considered to be illiquid. 

Laszlo Arany, author of the report, notes: “The vast majority of these portfolios were very liquid. However, there were a handful of funds that warranted further examination. Seven of the funds breached the SEC’s 15% illiquid-holding limit, and approximately 1% of them had less than half of their holdings in the highly liquid category.

“In short, the liquidity profile of these funds may be misaligned with anticipated redemption requests.”

The issue of liquidity has gained greater prominence following the suspension of Woodford Equity Income. In the latest update to investors, at the start of July, Woodford gave no clear indication on how long the fund would be suspended for, noting that there was “no prescribed limit” for how long it can remain suspended.

Following its suspension, the Bank of England has said it is considering new rules to help open-ended investment funds cope with waves of redemptions.

In its Financial Stability Report, the Bank said that it would work with the Financial Conduct Authority to look at the risks associated with the liquidity mismatch of open-ended funds that invest in illiquid assets.

Seperately, the Investment Association (IA) has also announced it is considering introducing a new type of open-ended fund structure, which will be called a long-term asset fund.

The basic principle is that this type of fund will facilitate investments in illiquid assets, such as property, infrastructure, private equity and private debt. To provide a better structure for these investments, the fund will be able to receive new money to invest, but investors will not be able to sell their holdings on a daily basis. Instead, investor redemptions will be facilitated at “appropriate time intervals”, says the IA. However, long-term asset funds will  target only institutional investors.

Jargon buster: what is liquidity?

Liquidity is the availability of liquid assets (those that can be quickly and easily converted to cash without losing value) to a company or fund. If the holdings in a fund are deemed ‘liquid’, investors should have no problem withdrawing their money. If the holdings are harder to sell and are ‘illiquid’, funds will struggle to meet any increase in investor withdrawals on a daily basis. In normal market conditions, funds that hold illiquid assets will have sufficient liquidity for their needs, often by keeping a certain amount of cash, but in times of heavy selling it is a different story.

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