Editors’ note: Following the publication of this article, H2O Asset Management contacted us to challenge the financial media’s characterization of this saga, including some of the sources we used, and stressed that they did not gate the funds in question. We have amended our text to clarify that the firm introduced its policy of swing pricing in 2017, and we are providing both sides of this story as a way to highlight the importance of analyzing funds’ redemption rules yourself.
Do you know how easy—or hard—it is to redeem your fund investments for cash? We think you should. In our view, difficulties redeeming funds in three high-profile cases underscore the importance of carefully considering liquidity—how quickly and easily you can redeem your investment for cash without affecting pricing. Knowing what you own—including redemption rules and risks—can prevent an unpleasant surprise when you need cash the most.
Recently, investors in funds from UK fund firms Woodford Investment Management and H2O Asset Management, as well as GAM Holding AG—a Swiss asset manager—had various issues withdrawing their money.[i] On 3 June, Woodford suspended trading in its largest fund, locking clients’ assets up indefinitely. Later in June, H2O announced investors wanting to sell would face “swing pricing,” which means investors seeking to withdraw quickly must take a 3% to 7% discount on their investments’ value—a policy the firm first announced in 2017.[ii] Meanwhile, last summer, GAM also suspended trading in its Absolute Return Bond Funds, which amounted to 12% of its assets.[iii] As of late spring, it was still winding down those funds.[iv] The common thread in all three cases: Funds claiming daily access to your money but investing significant portions in hard-to-sell assets.
If quick access to cash is important to you, your due diligence should assess whether an investment is likely to provide that. That means in periods of rising markets like June 2019 (as these three examples illustrate) or in periods of greater market turmoil.[v] If the fund is concentrated in illiquid, rarely traded investments, withdrawals could be restricted under certain conditions or at managers’ discretion. UK real estate funds after 2016’s Brexit vote are a good example. Many experienced large outflows, prompting some managers to freeze withdrawals.[vi] To meet investors’ redemption requests, they would have to sell property holdings fast—necessitating fire-sale prices. So, to avoid selling a glut of properties under duress at distressed levels, some halted redemptions temporarily.
We suspect being unexpectedly locked into a fund would be excruciating. To prevent this, it behoves you to explore potential withdrawal rules and lockup restrictions and when they might apply. Maybe read the prospectus. Maybe see if similar funds have ever blocked withdrawals. Make sure you ask your financial professional hard questions about liquidity and the possibility of redemption gates blocking withdrawals. Further, a fund should be able to provide you with an assessment of its holdings’ liquidity. The manager is likely aware of how its assets trade and should be forthcoming. If they aren’t, that could also be a sign of potential trouble.
Brokers selling the fund should also be upfront. If you are being sold a “top buy” fund—as many Woodford funds were considered by UK brokers—ask about its liquidity. Ask how returns were achieved and whether there is any leverage employed. If you find a lockup risk but still think the investment is compelling, that may be fine! Your goals, needs and wants are ultimately what matter most. But, in that event, we think it is best to ensure you then have other means of meeting near-term cash flow needs, just in case.
There are other ways of evaluating lockup potential. You can investigate a fund’s holdings yourself to see how liquid they are. Assess how much of the funds’ holdings are listed versus unlisted. The relevant EU directive regulating funds sold to the public—the Undertakings for Collective Investment in Transferable Securities—caps illiquid investments to 10% of a fund’s holdings. The nearer your fund is to this threshold, the higher the likelihood of lock up. However, even this measure isn’t a cure-all. It applies only to unlisted shares that don’t trade on an exchange. If a fund holds assets that aren’t listed—which aren’t “quoted”—it is a tell-tale sign they probably aren’t liquid. But listing doesn’t always ensure liquidity, as some minor, obscure exchanges don’t require much trading. That happened in the Woodford situation, where the fund held unlisted illiquid assets and listed illiquid assets. However, in our experience, this scenario is the exception, not the rule.
A fund’s daily price movement compared to the overall markets of similar securities can be another clue. If you have a 100% global equity fund and it swings far more (or less) than a similar global equity index like the MSCI World, you may want to ask your financial professional why. It could be a sign of leverage or illiquid assets. Whatever your fund is, we think finding an appropriate equity or fixed-interest security index to compare its movement to—a benchmark—is an important step.
These recent lockups may seem scary, but you can protect yourself. Just use your scepticism, investigate, ask hard questions and hold your financial professional’s feet to the fire by using a benchmark.
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Investment management services are provided by Fisher Investments UK’s parent company, Fisher Asset Management, LLC, trading as Fisher Investments, which is established in the US and regulated by the US Securities and Exchange Commission. Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.
[i] “GAM. Woodford. H2O. There’s Never One Cockroach,” Mark Gilbert, Bloomberg, 20/6/2019. https://www.washingtonpost.com/business/gam-woodford-h2o-theres-never-one-cockroach/2019/06/20/c7a70b9e-936d-11e9-956a-88c291ab5c38_story.html
[ii] “H2O Moves to Stem Outflows After Liquidity Issues,” Sebastian Cheek, Portfolio Adviser, 24/6/2019. https://portfolio-adviser.com/h2o-moves-to-stem-outflows-after-liquidity-issues/
[iii] “Gam Strikes Deal With Steel Magnate to Offload ARBF Stub,” Kristen McGachey, Portfolio Adviser, 17/4/2019. https://portfolio-adviser.com/gam-strikes-deal-with-steel-magnate-to-offload-arbf-stub/
[iv] “Gam Warns Profits Have Been Wiped as ARBF Liquidation Winds Up,” Jessica Tasman-Jones, Portfolio Adviser, 10/7/2019. https://portfolio-adviser.com/gam-warns-profits-have-been-wiped-as-arbf-liquidation-winds-up/
[v] Statement is based on the MSCI World Index return in June 2019.
[vi] “UK Real-Estate Funds Question Redemption Strategies Post-Brexit,” Peter Grant, The Wall Street Journal, 7/9/2016. https://www.fnlondon.com/articles/uk-real-estate-funds-redemption-strategies-compared-20160907