Investors are often lambasted for their short memories. However, recollections of the redemption freeze on a handful of commercial property funds in late 2007, and subsequent dash for cash in 2008, still brings a collective grimace to the faces of professional fund pickers.
Commercial property is not the only asset class where liquidity is of concern. Small cap and emerging market equities, private equity and bonds are among the others, while hedge funds, investment trusts and ETFs have come under scrutiny as investment vehicles.
For Nick Sketch, senior investment director at Rensburg Sheppards, the connection between liquidity and what can be seen as fashionable investments applies widely. For example, Asian mid-cap stocks are very liquid today precisely because of all the cash that has been heading East, but he warns that that this could dry up very quickly if markets were to weaken.
He says: “At the very least, that would widen investment trust spreads and increase the real cost of active management in the sector – at worst, whole sectors can become pretty illiquid and can destabilise funds. Investors should only be invested in these assets if they believe that the return on offer compensates them for this risk.”
Long-term investing
However, Sketch stresses too that genuine long-term investors can benefit from these fashion swings by buying less liquid investments when the extra return that they offer over otherwise comparable investments is large, and/or moving the other way when the excess return offered looks too small.
He adds: “For someone taking a 20-year view today, the pain of the last crisis means that many distressed debt investments that are fundamentally sound offer very appealing returns for the long-term risk taken, and so do some hedge investment trusts. Several private equity investments appear to offer good compensation for fundamental illiquidity through low entry prices and much the same is true for commercial property.”
Nicholas Cooling, manager of the Marlborough Balanced Fund, believes that those investors who do wish to invest in real property assets should aim to do so through larger funds, which are less likely to come across liquidity issues. Understandably, he says it is also prudent to limit an investor’s exposure to the asset class.
Down the cap scale
It is all very well avoiding the likes of commercial property, or even more esoteric emerging markets, but what about an asset, such as UK equities, which is omnipresent in virtually all client portfolios? Investors are unlikely to experience liquidity problems investing in mega cap stocks, but what about those fund managers that operate further down the cap scale?
Edward Legget is manager of the £435m Standard Life UK Equity Unconstrained Fund, which holds 50 stocks, only around a third of which are FTSE 100 listed. The appeal of mid caps is obvious – in 2010, there were 129 mid cap stocks that grew over 30%, compared to just 29 in the FTSE 100. However, says Legget, liquidity is low outside of the UK’s top 50 stocks and he has to trade patiently.
He explains: “I have a very big holding in [housebuilder] Galliford Try, and I own around 10% of that company. It has had good numbers today, but it performed poorly last year and is now a very difficult stock to buy.
"But also, you can have big holdings in companies that go wrong and you cannot sell them. You have to take a longer-term time horizon and, outside of the FTSE 100, it is very difficult to say that I will buy something this week and then flip it in two weeks’ time because liquidity is not there.”
It is arguable that cash weightings across the financial services industry still remain too high, a legacy of the scars borne of illiquidity. Nonetheless, for wealth managers it seems that not being able to access your money when you want it brings just as much grief as heavy losses.
A longer version of this article appears in the June edition of Portfolio Adviser.
