Don’t reinvent the wheel when it comes to fund liquidity

Mark Carney © Getty Images
Mark Carney: open-ended funds are “built on a lie”

We don’t need new fund structures to tackle liquidity concerns with open ended funds– the ideal vehicle already exists – investment trusts.

The fallout from the gating of Neil Woodford’s open-ended equity income fund, as he tries to sell illiquid assets to pay back disillusioned investors, continues to reverberate through markets. Investors in the UK pulled £1.9bn out of actively-managed open-ended funds in the three months to the end of June, notes Vicky McKeever on Citywire. That’s the biggest such rush since the run-up to the Brexit referendum in mid-2016. Meanwhile, the issue is in the sights of both the Bank of England (Mark Carney has described open-ended funds as “built on a lie”) and the regulator.

The problem with open-ended funds owning illiquid assets was made very clear three years ago, when commercial property funds were shut in the wake of the Brexit vote in 2016. Woodford has merely added urgency to the issue. Now the Investment Association, the trade body for open-ended fund managers, is proposing a brand new type of fund to tackle the problem – a “long-term asset fund”. This open-ended fund would own illiquid assets, but investors would only be allowed to withdraw their money at “appropriate time intervals”, and would also have to pass some sort of “appropriateness tests”.

There are some practical issues here (what’s an “appropriate time interval”?). But the main one is that we already have a vehicle that is ideally suited to holding illiquid assets, which also allows investors to withdraw their cash in a pinch – investment trusts. For a full definition, see below. But the key point about investment trusts is that, unlike open-ended funds, the number of shares is fixed (new investors buy shares from previous investors who sell out), which means the manager can never be forced to sell due to a “run on the fund”. A side-effect is that it makes asset-gathering (selling as many shares in the fund as possible, to boost the fees collected) a trickier proposition, which is one reason why open-ended funds remain so popular with the industry.

So if you’re in the market for an actively-managed fund that invests in less liquid assets, you need not wait – just trawl the investment-trust sector. One trust that MoneyWeek has recommended several times is Syncona (LSE: SYNC) (previously the BACIT trust). The trust invests in promising early stage life-sciences companies and has an excellent track record (its net asset value climbed by nearly 40% in the year to the end of March). Another interesting option is Herald Investment Trust (LSE: HRI), which invests in smaller listed and some unlisted technology and media companies around the globe. The trust also has a strong record (up 90% in the last three years) and trades on a discount of 16%.


I wish I knew what an investment trust was, but I’m too embarrassed to ask

Investment trusts are collective investment schemes. Just like any other fund, they allow investors to pool their money and invest in a wide range of companies and other assets, enabling them to diversify in a convenient way. However, there are some key differences between investment trusts (which are closed-end funds) and their open-ended peers.

Investment trusts are listed companies whose business is to invest in other companies. This means they raise an initial amount of capital when they go public. After that, if you want to invest in the investment trust, you have to buy the shares in the open market. This differs from an open-ended fund, where any new money results in the creation of new units (and any sale results in the redemption of those units).

As a result, the value of the shares in an investment trust can vary from the value of the underlying portfolio (the net asset value – NAV). If the share price is higher than the NAV per share, then the trust is said to be trading at a premium. If the share price is lower, then it is trading at a discount.

This can create interesting opportunities. If a trust trades at a discount of 10%, say, then it means you are effectively getting £1 worth of assets for 90p when you invest. This is more common than you might think. Be warned, though – the only way to benefit from buying at a discount is if the discount narrows and you then sell the shares at a profit. There is no guarantee that will happen. So rather than looking at the absolute level of the discount or premium, the best bet is to compare it with the five-year average to see if it represents good value or not.

One other aspect of investment trusts to be aware of is their ability to borrow money to “gear up” their portfolios. “Gearing” or “leverage” cuts both ways – in good times it can boost returns; in bad times, it can exacerbate losses. So it’s always worth checking how highly geared a trust is.