In light of the ongoing issues surrounding Woodford Investment Management, we have been asked by a number of our introducing advisers and clients for our views on the situation and how we manage liquidity within Psigma portfolios.
The first point to make is that we take liquidity incredibly seriously and questions over liquidity are as vital to our assessment of the suitability of a specific fund as the potential for returns and risks are. We are amazed by how quickly our industry has forgotten the problems that arose in the financial crisis of 2007-9, where many funds became gated and suspended redemptions. Indeed, perhaps the biggest culprits that prevented investors withdrawing their money a decade ago were the “bricks and mortar” UK commercial property funds, where such property funds’ mix short term investor cash flows with long term illiquid assets, but it took less than a decade for them to repeat the trick as news over the UK’s decision to leave the European Union impacted prices and worried investors tried to pull their assets. This is precisely the sort of situation we try to avoid at Psigma, even if we have to acknowledge that sometimes it will lead to us missing out on opportunities.
So how do we try to manage liquidity appropriately within our clients’ portfolios? Our starting point is that we only invest in daily-dealing and UCITS recognised funds. Unless it is a specialised situation, where less frequent dealing is actually a benefit to our clients (and there have been isolated examples in the past), we will not bend on this rule within our investment process. However, as the situation with the Woodford Income fund is currently showing, our blunt rule is insufficient in trying to ensure that our clients’ assets do not become gated in external funds in extreme market scenarios. We therefore carry out a great deal of due diligence on the underlying investments held within each and every fund that we hold on our “Core Fund Buy List”. We are able to do this as we have a “Core Fund Buy List” of around 35 funds, which is unashamedly small by comparison to other “Buy Lists” that our peers manage. By insisting upon regular meetings with the fund managers of our selected external funds we get great insight into the small list of funds that we own on our clients’ behalf and we can monitor changes closely that could impact upon liquidity. For example, the issues that are arising at Woodford Investment Management are coming from the problematic mix of heavy investor redemptions and a sizeable weighting within the fund to illiquid unlisted company shares. As a guide to how we view such investments, we would consider them to be a “red flag” within our fund selection and due diligence processes and certainly could not contemplate recommending a fund that had quite such a high allocation in such investments in a daily dealing unit trust that Woodford’s daily dealing Income fund held. As a guide, our two “core” recommended UK active funds do not hold any exposure in unlisted company shares.
Fund size is also an important consideration when assessing a fund for use within our client portfolios. Our bias is to avoid very large funds when investing in fixed interest markets, which can be less liquid than investing in equity markets, particularly when investing in corporate credit or asset-backed securities markets. With this in mind, we have structurally shifted our clients’ fixed interest allocations away from traditional unit trusts and towards funds that are solely for our clients’ use. Not only does this allow us to optimise the investments within the funds to suit our ongoing market views, but it also allows us to have far greater control over liquidity. We have a great deal of comfort that such an approach means we can exit positions when we want to and not suffer disadvantageous prices. It also means we are not at the mercy of other investors and their decisions over buying, holding or selling a fund. Importantly our approach is no more expensive to pursue, it just takes more work, but in our view is well worth the extra effort.
Further proprietary monitoring checks on external fund sizes include a monthly report detailing the changes in size of each of the funds on our “Core Fund Buy List” and how large Psigma’s exposure is to each fund. We specifically review a fund where they are enjoying a great deal of success in growing assets and when a fund starts to lose assets, outside of ongoing market movements. Fund flows undoubtedly can help or hinder a manager’s ability to generate performance and are underestimated as risk factors in our view. We also monitor how large Psigma’s holding is in a specific fund and highlight any fund where we own over 20% of the total assets of that fund. To be clear, we do not object to owning a higher proportion than 20% of the units of a specific fund, but we need to conduct further monthly checks into the ongoing liquidity of that fund. With that in mind we regularly ask external fund managers to detail to us how long it would take them to liquidate their whole portfolio, providing us with extra insight into how we can manage liquidity risk in stressed market conditions.
Hopefully this note serves to show how important we consider liquidity to be within our client portfolios and how we scrutinise external funds to make sure that they meet the requirements that we have. The steps that we have taken might not make us immune from liquidity constraints in extreme market conditions but they should help us to reduce the risk of fund suspensions significantly.
Chief Investment Officer
- We take liquidity incredibly seriously and questions over liquidity are as vital to our assessment of the suitability of a specific fund as the potential for returns and risks are.
- We carry out a great deal of due diligence on the underlying investments held within each and every fund that we hold on our Core Fund Buy List.
- We get great insight into the small list of funds that we own on our clients’ behalf and we can monitor changes closely that could impact upon liquidity.
- Fund size is also an important consideration when assessing a fund for use within our client portfolios. Our bias is to avoid very large funds when investing in fixed interest markets
- We also monitor how large Psigma’s holding is in a specific fund
- We regularly ask external fund managers to detail to us how long it would take them to liquidate their whole portfolio, providing us with extra insight into how we can manage liquidity risk in stressed market conditions.
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©2019 Psigma Investment Management. This communication has been approved and issued by Psigma Investment Management. Psigma Investment Management is a trading name of Psigma Investment Management Limited. Authorised and regulated by the Financial Conduct Authority. Registered in England and Wales No. 5374633. FCA Registration No. 478840. Registered office: 11 Strand, London WC2N 5HR. A Punter Southall Group Company