The collapse of the Woodford Equity Income fund may have done a great deal of harm to investors, but the hope is we can at least avoid similar crises in future. The silver linings are there to be found if you look hard enough: the scandal has served as a fresh warning that open-ended funds and illiquid assets are not a good mix, while also forcing investment managers to look more closely at how quickly and easily they can sell their holdings.
In fairness, fund managers have generally held off from including the likes of unlisted companies in open-ended funds, as Neil Woodford did. But other illiquid holdings are still causing trouble in certain instances. Take the recent temporary suspension of 7IM's Income Portfolio and Absolute Return Portfolio funds because of “ongoing uncertainty around the continued illiquidity of two assets which cannot currently be sold”.
Both funds list a decent level of exposure to Xenfin Securitised Debt Fund, a vehicle that has been suspended since 2019. The 7IM funds have also both held Drum Income Plus Reit (DRIP). In March, this trust’s board warned that it had failed to reach a decent level of scale, making it difficult to generate “any meaningful liquidity” in the shares. The board now plans to carry out a strategic review into the trust’s future.
It’s unlikely the suspension of these small 7IM funds will directly affect DIY investors and suspended funds can successfully reopen. But it’s a reminder that liquidity troubles have not entirely gone away.
Add to that some disconcerting findings from a probe into liquidity management in open-ended funds, and we understand the potential extent of the issue. The Bank of England, which conducted the study together with the Financial Conduct Authority (FCA), found that most corporate bond managers in part of its assessment had appeared to overestimate the liquidity of their holdings, with some appearing “particularly overoptimistic” on this front.
A similar investigation by another regulator, the European Securities and Markets Authority, identified liquidity management “shortcomings” in the case of some undertakings for collective investment in transferable securities (Ucits) funds.
At a time when unlisted companies and illiquid alternative assets are generating a buzz, this reminds us of the need for vigilance. For some, it may be a rallying cry for investment trusts. Smaller companies, private equity, debt, direct infrastructure holdings and all manner of other hard-to-shift assets are accessible via trusts, without concerns about your ability to exit. That said, selling out of a troubled investment trust can still involve offloading your shares at a low point and realising a loss.
Open-ended funds have continued to buy less liquid assets such as bonds and smaller company shares without a major crisis in recent history. But if you hold such a fund, it is worth understanding how they manage liquidity issues. Do they have a major cash allocation, or a stash of more liquid shares or bonds that can sold to meet investor redemptions? If a fund is buying less liquid assets, does it become an issue when it grows to a certain size and how is this managed?
Liquidity crises and fund suspensions should hopefully remain rare, but it's a problem that has not gone away following the Woodford crisis. Treading carefully would be advised.
