The Financial Conduct Authority (FCA) is to implement more stringent rules for open-ended funds that invest in illiquid assets such as commercial property, but is not going to prevent them from holding high levels of cash.
The FCA, which has been assessing the treatment of illiquid assets after several open-ended property funds suspended dealing amid uncertainty following the 2016 Brexit vote, backed away from a proposal to discourage such funds from running large cash weightings. Many of the larger open-ended property funds have run high cash weightings in recent years, which would allow them, if necessary, to meet investor redemptions without having to sell their investments. The FCA had previously warned that this could create a first-mover advantage for investors, leaving others trapped. High cash levels can also create a drag on investment returns.
“We have decided not to take the proposal on limiting cash buffers forward,” said the FCA. “There was clear opposition to the proposed guidance on liquidity buffers and concerns about whether the guidance would be ineffective or even counter-productive. While cash levels do have an impact on a fund’s performance, investors can acquire information on different funds’ cash policies and holdings. This provides them with a choice as to which level of cash is optimal for their needs. Where a fund with illiquid assets needs to prepare for a large expected redemption, it may be necessary to accumulate cash in preparation, selling assets at the point of time when a favourable price can be achieved.”
The FCA will also require relevant funds to suspend trading if there is material uncertainty around the value of “immovable” assets representing 20 per cent or more of a fund’s investments. However, a fund manager may continue to deal if they have “a reasonable basis for determining that it is not in the best interests of investors to suspend”.
The measures, detailed in an FCA policy statement, come as investors increasingly focus on the treatment of illiquid assets in open-ended funds, which tend to offer daily dealing. Several open-ended property funds temporarily suspended trading in 2016 and, more recently, the suspension of LF Woodford Equity Income (GB00BLRZQB71) has reminded investors that illiquid assets can create problems when fund managers need to quickly sell their holdings. The FCA said this episode shows that liquidity considerations are “not confined to open-ended funds with exposure to property and other immovables”, and could apply to bonds and even listed equities.
Ryan Hughes, head of active portfolios at investment platform AJ Bell, said the FCA’s approach meant that investors were “likely to see funds suspend dealing more frequently and sooner than they would have done in the past”. He also criticised the decision not to crack down on high cash allocations.
“We’ll see a continuation of the status quo, where property funds often have around 20 per cent of their assets in cash, on which they charge the full management fee and which serves as a considerable drag on returns for investors," he said.
The FCA will also create a new category of funds investing in "inherently illiquid assets” which will be subject to higher levels of oversight and have to create liquidity risk contingency plans from September 2020. These will include Non-Ucits Retail Schemes (Nurs) which aim to invest at least half of their assets in inherently illiquid assets, as well as Nurs that have invested at least 50 per cent of their money in inherently illiquid assets for at least three consecutive months over the past year. Nurs funds tend to have greater investment flexibility than those governed by the Undertakings for the Collective Investment in Transferable Securities (Ucits) rules, and more commonly focus on areas such as property rather than mainstream assets such as equities.
