Open-ended funds and liquidity – Vorsprung durch Technik ?

For some time, British motorists had an eye on the quality and technical pre-eminence of German cars, epitomised by the now famous Audi tagline “Vorsprung durch Technik”.

Following the suspension of the Woodford Equity Income fund, the debate about liquidity in open-ended funds has all of a sudden expanded from property funds into equities. The FCA is pressured to look further into liquidity of open-ended funds, beyond the ongoing consultation that only covers property funds.  Maybe it’s a good time to see how the German regulator dealt with this issue?

The Financial Crisis of 2008/09 was a watershed moment for German Open-ended Real estate funds (with the catchy acronym GOREF). Offering daily liquidity, many could not handle increased redemptions, and had to gate, for the first time in history. In late October 2008, more than a dozen funds suspended redemptions. This led to a reduction in assets under management from €91bn in 2010 to €78bn in 2015.

Naturally, the regulator was looking into measures to avoid such a situation in the future, initially exploring an abolishment of open-ended mutual real estate funds. This was heavily criticised, and the revised regulation proposed a change to the daily liquidity provisions. Effective from 2013, acquired units in an open-ended real estate fund needed to be held for at least 24 months and they can be redeemed after a notice period of 12 months.

Five years later, it is highly informative to see the impact of these changes. Investors have embraced these changes, and the sector is growing. In 2017 alone, the sector registered net cash inflows of €5.5bn, and since 2015 some 10 new such funds were launched. Assets in the sector are again above pre-crisis levels.

Are there any lessons that can be learned for the UK market? We believe so.

  1. Illiquid investments are valuable investments. First, they perform an important source of capital for the economy. The FCA Chief Executive Mr Bailey insisted that “investment in illiquid assets is important for the wider economy” (FT, 10.6.2019). Second, many high net worth investors benefit from the “illiquidity” premium amongst others via Private Equity investments. We argued previously for the “Democratisation of illiquid investments” to ensure all investors can benefit from such longer term investment opportunities – View our argument here.

  2. Invest for the medium to long-term: Savers looking to invest, in particular those working with a Financial Adviser, are typically only recommended investment products if their investment horizon is over 5 years. So why the obsession with daily liquidity? We are seeing more and more advisers and multi-asset allocators opting for long-term, core allocations to certain less liquid asset classes, alongside more liquid holdings which are re-balanced more frequently.

  3. Better Disclosures and Communication. We previously supported better disclosures and communication proposed by the FCA. The FCA regulation is very clear in its ambition to treat all customers fairly. Whilst fund managers cannot provide some investors preferred communication over others, it is paramount that all investors, retail and institutional, are fully aware firstly of the existence of prospect clauses allowing for gating, and secondly of a fund’s liquidity profile on an ongoing basis. A suspension should not come as a complete surprise to investors and advisers. If current disclosures and communications for private and institutional investors are not sufficient, they should be enhanced.