New Warning on Liquidity of Smaller Company Funds

After liquidity problems in the commercial property sector, a report from SCM Direct asks whether UK Smaller Company funds could be the next sector to leave investors stranded

Emma Simon 11 October, 2016 | 2:22PM
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New research from SCM Direct – the investment manager – suggests that investors could face potential liquidity problems with Smaller Company funds.

This research analysed the liquidity of the largest funds across various Investment Association sectors, by seeing how long it would take these funds to sell 10 or 20% of their assets in ‘normal’ trading conditions.

Most sectors – including UK Equity Income funds, UK All Companies, European Companies and Emerging Market Equity funds – would be able to sell up 20% of assets within one day, and 10% of assets is less than one day.

However, the research indicated UK Smaller Company funds would take an average of two days to sell 10% of their assets - and five days if they needed to redeem 20% of assets under management.

Liquidity ‘Mismatch’ With Some Smaller Company Funds

SCM Direct said: “A fund with cash and liquid stocks can use these as a buffer to meet redemptions but, as the property fund debacle showed, this may only offer investors temporary protection. Once significant redemptions occur, and the liquid investments are extinguished, the fund may be forced to either accept serious markdowns to sell illiquid assets, or suspend [trading].” 

It added: “73% of UK Smaller Company funds had a liquidity mismatch between their underlying holdings and the daily liquidity offered to investors should 20% of their funds be redeemed.”

The report identified eight Smaller Companies funds (which collectively are worth £4.6 billion) where it would take two weeks (or 10 business days) to meet a 20% redemption.

It warned that if funds were forced to redeem 50% of assets then this could take up to 53 business days, raising the spectre that funds could suspend dealing in such circumstances - meaning investors may not be able to access their savings.

Smaller Company Shares ‘Fundamentally Different’ From Commercial Property

However, a number of leading advisers urged caution and said investors should not be unduly concerned about liquidity problems in this market.

Laith Khalaf a senior analyst at Hargreaves Lansdown says: “This report is scaremongering. Funds focusing on smaller company shares are fundamentally different from commercial property funds. The process for transacting property is considerably longer, which is why there have been occasions when these funds have been forced to suspend trading – meaning investors can’t get their money out.”

He adds that he has never known any UK Smaller Company fund suspend trading. This did not happen in the financial crisis of 2008, nor after the dotcom crash at the start of 2000.

“Any fund could face liquidity problems if there was a sudden stampede to the door. Shares in Smaller Companies are less liquid than FTSE100 stocks. But this doesn’t mean that these funds are likely to shut the doors any time soon - even in the event of a market correction.”

He added that the scenarios where funds had to sell 50 or 100% of assets seemed “somewhat far-fetched”.

Patrick Connolly of Chase de Vere agreed that he had never known any Smaller Company fund suspend trading: “There’s always this possibility for funds investing in more illiquid assets - such as property, smaller company shares or frontier market, but this would be an extreme situation.”

Should Funds Move to Weekly or Monthly Pricing Models?

Alan Miller, chief investment officer of SCM Direct said he wanted to the report to highlight the issue of liquidity. The report concluded: “It would be appear prudent for the FCA to encourage advisers and fund groups to look beyond simply how much a share price moves up or down each day in terms of assessing fund risk. Tofulfil the ‘Treating Customers Fairly’ principle, investors should be advised that illiquid investment are higher risk.

“Should the FCA not address this issue with UK Smaller Company funds, where a typical fund has a fundamental mismatch between the liquidity of its holdings and the daily liquidity it offers investors? If it takes say a week to sell 10% of the fund on a normal basis should the fund not have weekly subscription, or if it takes a month or more – could it move to a monthly subscription basis?”

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Emma Simon

Emma Simon  is a financial journalist, specialising in investment and consumer issues, writing for Morningstar.co.uk