There can be little doubt that the move to stem flows into funds is well intentioned. The desire to protect performance for existing shareholders by not constraining managers with huge assets is laudable. Managing fund flows in the open-ended sector can undoubtedly impact on performance, particularly when there are extreme events such as a manager departure or a sector falls substantially out of favour.
However, it remains a crude tool. Often funds will see significant inflows after the announcement of a soft-closure as investors rush to get money invested in anticipation of a hard close. Often where it has worked to stem flows, it has coincided with a marked lack of popularity for an asset class – such as emerging markets or corporate bonds.
This is a problem at a time when the industry is seeing greater concentration in a smaller number of funds. An unintended consequence of the Retail Distribution Review has been to hand fund selection power to a smaller number of analysts and discretionary brokers, as financial planners increasingly outsource. Those analysts look for similar criteria in funds, leading to increased fund flows into a small number of funds.
This is a problem for the industry as a whole. If there is no properly effective way to cut off flows and these funds simply keep getting bigger until performance starts to fail, it will ill-serve investors.
The solution would appear to be to put any asset class where there is a danger that there could be liquidity constraints in a closed-ended fund. The trouble is, this could include most asset classes in the wrong type of environment or if fund flows grew too large.
Equally, closed-ended funds also have liquidity problems: Winterfloods recently warned that many income trusts now trading at a premium could suffer in an environment of rising interest rates if the income they provide were to be deemed less valuable by investors and the trusts sold off. In this way, liquidity constraints can hit the closed-ended sector too, but in a different way.
There is no elegant solution. For investors, the key is to ensure that a company is properly monitoring liquidity considerations and acts to halt inflows a long time before it is likely to become a real issue for a fund. As liquidity varies in different market conditions, judging when a fund is likely to hit capacity problems is always a hit-and-miss affair, but that doesn’t mean fund companies shouldn’t have a strategy in place to deal with it.
It may also likely to mean avoiding the larger funds. Mark Barnett may have managed to steer the Invesco Perpetual High Income and Income funds to outperformance of their benchmark since the start of the year while the funds have been experiencing outflows, but in an ideal world a fund manager would not be operating with these constraints.
