Interactive Investor

Fund liquidity: what it is and why it matters

Fund liquidity is back in the spotlight. Kyle Caldwell explains why fund suspensions can occur.

4th March 2022 09:18

Kyle Caldwell from interactive investor

Fund liquidity is back in the spotlight. Kyle Caldwell explains why fund suspensions can occur. 

Fund liquidity concerns have resurfaced following the suspension this week of Russia-linked funds in response to the closure of the Moscow Stock Exchange. 

What is fund liquidity?

Most funds are “liquid”, meaning that investors should not have problems withdrawing their money. 

Liquidity is basically a fund’s access to liquid assets, for example, cash, or those assets that can be quickly and easily converted to cash without losing value.

Most funds are highly diversified and hold a wide spread of investments that are listed on a stock market, so they are unlikely to have liquidity problems.

The suspension of Russia-linked funds is unique and unsurprising given that the Moscow Stock Exchange is closed. Fund managers are unable to sell the investments held in the fund to return money to investors. 

Why does liquidity matter?

For an investor, liquidity matters because you can end up not being able to access your money if fund suspensions are put in place. 

Investors in commercial property funds are particularly vulnerable. Such funds have put suspensions in place on several occasions, including following Covid-19, the Brexit vote and during the financial crisis. 

In normal market conditions, it is not a problem for investors to withdraw money on a daily basis, as a portion of the portfolio remains in cash, typically 10% to 20%.

However, during times of heavy selling, it is a different story, as the cash buffer is depleted. This makes it difficult for open-ended commercial property funds to meet withdrawals on a day-to-day basis.

This is because property sales of the shops, offices and factories held in portfolios are not quickly or easily arranged, particularly in times of market uncertainty, and it is therefore very difficult to raise money quickly.

Such a scenario can negatively impact investors who remain in the fund, as the manager is forced to sell investments for less than they are worth to gather enough money to repay investors who have hit the sell button.

Unlisted holdings are also inherently illiquid, due to not being listed on the stock market. The 10% limit on unlisted holdings for funds sounds like a small percentage, but the suspension and subsequent closure of the LF Woodford Equity Income fund shows that illiquid holdings can prove very problematic when investors rush to the exit.

Unlike funds, investment trusts do not have this liquidity problem. Under the trust structure, a fixed number of shares are issued, raising a fixed amount of money for the manager to invest in a portfolio of assets. Those shares are traded on a stock exchange and their price fluctuates according to demand and supply. Crucially, the fund manager does not have to sell or buy shares depending on whether they are attracting or losing investors. This makes trusts a more suitable vehicle to hold illiquid assets and also arguably allows the fund manager to take more of a long-term view while running the portfolio.

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