As published on investmentweek.co.uk, Thursday January 2, 2020.
Changes to the structure of open-ended funds holding illiquid assets proposed by the Bank of England (BoE) are “likely to be complicated to execute and explain” and would require “a change in attitude from investors, fund managers and platforms”, experts have warned.
In a warning that liquidity in open-ended funds poses a systemic risk to financial stability, the BoE's outgoing Governor Mark Carney said "there should be greater consistency between the liquidity of a fund's assets and its redemption terms".
The BoE's latest Financial Stability Report recommended: "Redeeming investors should receive a price for their units in the fund that reflects the discount needed to sell the required portion of a fund's assets in the specified redemption notice period.
"[And] redemption notice periods should reflect the time needed to sell the required portion of a fund's assets without discounts beyond those captured in the price received by redeeming investors."
While most commentators welcomed the long-awaited overhaul, they also outlined worries the industry must overcome.
According to Rebecca O'Keeffe, head of investment at interactive investor, investors essentially would be given a choice between being locked into a fund for prolonged periods of time or receiving a discounted price for their portion of said fund.
"This strikes us as a missed opportunity, given that there is a superior structure for illiquid assets already in place," O'Keeffe said, referring to investment trusts.
'Complicated to explain'
Carney added that the liquidity mismatch "should not be something that retail investors find out about in a gating situation; it's something that they should know in advance and have an expectation of how long it should take to get their money out".
But Adrian Lowcock, head of personal investing at Willis Owen, noted "introducing rules to 'vertical slice' is likely to be complicated to execute and explain" to retail investors.
Likewise, he continued, "introducing funds with different trading rules will just make the investment market confusing especially because in stress periods it is hard to know how long it will take to liquidate an investment".
Ben Yearsley, investment consultant at Fairview Investing, said that if the new rules meant investors could only get back the liquid portion of their investment when they redeem and had to wait for the illiquid portion for a specified period of time, it would cause an "administrative nightmare", adding to the complexity.
Lowcock added: "The more complex the rules, the greater the impact it will have on private retail investors, potentially putting many new investors off."
Lowcock also questioned how one would calculate a fair price for large illiquid assets such as infrastructure and property, while Yearsley said open-ended fund managers should already be valuing their investments on the basis that they will be sold the following day. "If they don't do that already, how are they fairly valued," he asked.
Yearsley added matching liquidity of the underlying investments with the redemption period of investors "makes sense", but claimed it would require "a change of attitude from investors, fund managers and, crucially, platforms".
"I don't think investors would have an issue with open-ended funds holding illiquid assets if they had a redemption period of, say, six months, as long as they know in advance that's the case," he said. "Daily dealing and illiquid doesn't work [at the same time]. But that doesn't mean open-ended can't work with the right lock-in period."
Meanwhile, Ryan Hughes, head of active portfolios at investment platform AJ Bell, said the proposals "make it clear that the current rules are not tough enough and that further measures are required to ensure that fund liquidity does not become a systemic risk".
"This is despite the fact that the FCA only proposed tougher rules for certain types of funds in September ," he explained.
Last September, in response to the liquidity crisis at Woodford Investment Management, the Financial Conduct Authority (FCA) set out new rules for non-UCITS retail schemes (NURS) investing in inherently illiquid assets.
The new rules, which will come into force on 30 September 2020, aim to ensure NURS managers provide investors with clearer and "prominent" information on liquidity risks, and the circumstances in which access to their funds may be restricted.
The FCA has said it will look to incorporate the newer proposals into its already published new rules.