In a lot of funds investing in illiquid assets, such as property, daily dealing is likely to disappear. “The idea that you can have property in a fund you can buy or sell shares in on a daily basis has been exposed to be a lie.”
Gavin Haran, head of asset management policy at the British law firm Macfarlanes, has been closely following the regulatory response to fund liquidity issues. The concern is, he says, concentrated on funds that are either daily dealing, or so short that they don’t give managers enough time to sell assets.
Several high-profile blow-ups have increased the spotlight on the issue in recent years. H2O Asset Management saw multi-billion-euro outflows from its corporate bond funds due to concerns over its unlisted asset exposure and at the time it was forced to suspend by the French regulator, it revealed it had nearly a third of one of its funds invested in illiquid bonds. Meanwhile, Swiss asset manager GAM ran into trouble with its now liquidated €9.5bn Absolute Return Fund range, which was found to have made investments in illiquid debt instruments without sufficient due diligence.
Perhaps the biggest fall from grace took place in the UK, with the closure of Neil Woodford’s eponymous firm after his funds struggled to meet redemption requests due to its illiquid holdings.
Liquidity concerns
Work on addressing liquidity concerns has been taking place for several years now, with the EU’s European Securities and Markets Authority (ESMA) publishing guidelines on stress testing for funds in 2019. But Covid-19 has turned the spotlight back on this issue as the pandemic put pressure on some alternative investment funds. According to ESMA, 38% of real estate funds in the EU outside the UK were affected by valuation uncertainties and 42% by material distortions in their income cash-flows. In March 2020, at least 76 European mutual funds had gated, according to Fitch Ratings.
ESMA found that 54% of real estate alternative investment funds were open-ended at the end of 2019, with almost half of commercial real estate funds – the largest category – offering daily liquidity to investors. This means that unless these funds have a large cash buffer, if something went wrong and investors wanted to pull their money out – which they have every right to – they might not be able to.
The figures were published on 8 April as part of ESMA’s annual report on the AIF sector, in which it also raised concerns over the mismatch between the potential liquidity of assets and the redemption timeframe offered to investors, which posed risks to the sector. This is expected to become a bigger problem as the size of the AIF universe grows and the trend towards the ‘democratisation of assets’ accelerates, increasing retail investor access to such funds.
ESMA said funds of funds, accounting for 15% of total NAV of AIFs, and real estate strategies, with an aggregate value of €802bn, are particularly vulnerable because they have the highest retail investor participation, at 28% and 21%, respectively.
That’s why Haran thinks that such alternative investment funds may move to a quasi-open-ended model where they don’t trade on a daily basis, but still have the pricing benefit.
‘I think what we see is a move away from daily dealing open-ended funds. The idea that you can have property in a fund you can buy or sell shares in on a daily basis has been exposed to be a lie,’ he said.
The suspension of many UK property funds in the aftermath of the Brexit vote and then again during the pandemic has shown the difficulty of meeting redemption requests when the underlying assets cannot be easily traded.
Chiara Sandon, senior policy advisor at the European Fund & Asset Management Association (EFAMA), stated that investing in less liquid assets should not prevent funds from offering regular redemption to investors, but discussions with investors about their redemption intentions should be part of a ‘sound liquidity risk management process’.
‘Investors should be informed of and accept all risks associated with investing through clear and transparent product documentation and/or the advice process which highlights liquidity risks before making any commitment,’ she said.
Sandon said that EFAMA’s members believe the European Long-Term Investment Fund (ELTIF) structure – once appropriately amended – should be the designated product for retail investors to access alternatives.
The ELTIF structure was launched in 2015 to enable long-term investments in infrastructure, unlisted companies and small and medium businesses. However, its use has not been widespread, and only around 50 vehicles have been set up so far.
One of the key challenges for fund managers conducting liquidity stress tests is the availability of data, she added, which is a problem that has been recognised by supervisors but not yet resolved.
‘For the purpose of improving risk management, we believe that the communication of information to fund managers including at least investor profiles and shares or units held by the different categories of underlying investors should be made mandatory and free of charge,’ the EFAMA representative said.