Most discretionary fund managers view portfolio managers as the most important function to speak with regarding liquidity even as the Financial Conduct Authority spells out that it is authorised fund managers (AFMs) that are responsible for managing a fund’s liquidity.
A survey of attendees at the Portfolio Adviser South West Congress event this month revealed 76% believe the portfolio manager is the most important person to liaise with on liquidity issues, 5% believe it is the AFM while the remainder, 19%, argue both are important alongside the depository as well. There were 21 respondents to the poll.
It took place the same week the FCA told AFMs that “ensuring effective liquidity management in funds is a central responsibility for you, and it remains your responsibility even if you have delegated investment management to another person”. It emphasised this remained the case even if investment management activities were outsourced, as was the case for Woodford Equity Income, whereby Link outsourced management to Neil Woodford.
The FCA said AFMs could mitigate liquidity problems through portfolio composition, effective fund governance and understanding the investor base and their redemption rights. This was on top of liquidity tools that could be used in times of market volatility and stress.
The letter echoes Woodford Investment Management’s claim that Link was responsible for overseeing liquidity issues. But although the letter was addressed to AFM chairs it also highlighted good practice for investment management firms when it comes to liquidity.
‘ACDs have not historically been customer facing organisations’
The FCA letter raises questions over whether fund selectors should have closer communication with AFMs, which include both authorised corporate directors and unit trust managers.
“ACDs and depositaries have not historically been customer facing organisations and are effectively contracted by the fund manager, so it will be interesting to see how their role evolves,” says Cornelian investment director David Appleton.
Cornelian deals directly with the fund manager on issues of liquidity as well as submitting a due diligence questionnaire. It will often also speak directly to the risk management function responsible for liquidity oversight.
The DFM likes independent risk teams that have a right of veto over the fund manager, remuneration that is not related to asset gathering, stress testing and defined fund capacity.
When it comes to less liquid holdings, Appleton looks for ownership portfolio exposure and limits, a policy regarding unquoted securities and minimum liquidity thresholds, such as half the portfolio being able to be liquidated in a day or 75% in a week.
Risks that fund managers will be biased
Other DFMs also mentioned they tend to seek information from the asset manager.
Quilter fund expert Nick Wood says it measures liquidity using a combination of data from the investment manager and its own internal systems.
“We ask the investment manager on a quarterly basis for a thorough assessment of the number of days it would take to liquidate the portfolio in current market conditions,” Wood says. “We subsequently back this up with our own analysis of the underlying holdings using all the available data.”
EQ Investors uses Bloomberg initially to build up an independent view of liquidity, says chief investment strategist Kasim Zafar.
But for a more informed view there is little alternative than to rely on the information provided by fund managers, Zafar says. “This clearly has risks of being incredibly biased.”
Due diligence on liquidity should be extended to AFMs
JB Beckett, former fund selector and independent funds board director, reckons fund selectors should extend their due diligence to the AFM and custodian and then use fund managers to understand the detail behind the numbers.
Technically, the fund manager, ACD and depositary should be looking at the same liquidity and trading reports, Beckett says, but buyers will be dealing with a sales contact at the asset manager, who will welcome dialogue, whereas the AFM is likely to respond in a more “mechanistic” way.
“The material difference is that you’ll have risk monitoring and pre- and post-trade compliance inside the fund manager and oversight of regulatory requirements at the AFM,” he says.
Portfolio Adviser asked Link about its approach to communicating with fund investors but it did not wish to respond.
Instead it provided a statement saying that it takes its responsibilities as an ACD “very seriously and [has] at all times acted in accordance with the appropriate regulations, and in investors’ best interests”.
Fund liquidity disclosure needs to be improved
All DFMs Portfolio Adviser spoke with felt liquidity reporting could be improved.
“We always check the liquidity situation with decision-makers directly but if there was an officially published measure of liquidity that we could refer to that might aid this process,” says GDIM investment manager Tom Sparke.
A breakdown of the portfolio into buckets based on how long it would take to sell would make sense, Sparke says. “Liquidity conditions change regularly, and always get tougher in a crisis, but knowing the extent of the fund that may be difficult to trade would be useful.”
As well as breaking down how long it would take to sell portfolio holdings, GBI2 managing director Graham Bentley reckons funds should disclose the largest shareholders and net sales and redemptions figures. FCA boss Andrew Bailey has been mulling whether rules need to be tightened around “supertanker” investors using third-party funds used by retail investors.
There are no standardised rules and thresholds set by regulators or industry that govern liquidity, says Appleton. “This has created a critical gap in the regulatory framework where participants such as asset managers and ACDs have had to develop liquidity risk management policies and procedures with very little guidance and, most clearly demonstrated by the Woodford case, insufficient oversight.”
Zafar would like to see an industry body take leadership on improving disclosure around liquidity rather than leaving it to the regulator. He points to the example set by the Hedge Fund Standards Board in the aftermath of the global financial crisis.
Investment Association chief executive Chris Cummings says the industry body welcomes the the latest statement from the FCA. “We are continuing to review our own guidance to help ensure consistency and continued high standards across the fund management industry, and we will work closely with the regulator and our members on its implementation,” Cummings said in a statement.
