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Do unlisted stocks belong in open-ended funds?

10 March 2023

The launch of a new long-term fund structure means investors can put their cash in riskier assets.

By Jonathan Jones,

Editor, Trustnet

Investing in illiquid assets through open-ended funds has been a hot topic for investors ever since the downfall of the once revered Neil Woodford and collapse of his eponymous firm Woodford Investment Management in 2019.

The former star manager invested in unlisted or difficult to trade stocks in his LF Woodford Equity Income fund and breached the 10% cap enforced by City watchdog the Financial Conduct Authority (FCA) when hit with redemption requests.

These sizeable redemptions from investors forced his funds to suspend trading. Ultimately, he was removed as manager – his flagship fund is still being wound down, while his other two portfolios (one had less exposure to unlisted stocks, the other was an investment trust) were taken over by other firms.

Yet it is not just a one-off problem. In 2016, following the Brexit referendum, property funds were forced to close the doors on investors trying to withdraw their cash as they could not sell properties quickly enough to meet redemptions.

This has been an on-and-off again problem for the sector in the intervening years, with CT UK Property recently announcing it was reopening after being closed for more than four months.

Enter the FCA with a bold proposal – the introduction of a new fund structure called the long-term asset fund (LTAF). In these new portfolios, investors will have to give 90 days’ notice if they wish to sell, thereby giving the investment managers more time to sell assets and make plans.

Now, this will not preclude some funds still needing to gate (suspend dealing) but should mitigate some of this risk.

Some have openly questioned the validity of this, with the strongest argument, in my view, being that if investors want to own illiquid assets they can do so through an investment trust.

Unlike open-ended funds, where investors give the investment manager money directly for units in a fund upon the understanding that it will give the value of the units back when they want to sell, investment trusts work differently.

They trade like stocks, with investors purchasing shares from those willing to sell. This means that the price can fluctuate significantly.

It means that, for example, investors may be facing share prices that have halved since they bought if purchasing an asset class that has fallen out of favour.

Last October, Richard Stone, chief executive of the Association of Investment Companies (AIC), said that trusts were the “tried and tested way to access long-term illiquid assets”.

“Their resilience demonstrates the benefits of the investment company structure which we believe will continue to provide the best way for investors to avoid the risks of liquidity mismatches and suspensions,” he said.

However, it does not save investors from perhaps the biggest threat – themselves. Indeed, we all know the adage of buy low and sell high, but in practice it is much more difficult.

While investors can sell (providing there is a buyer), they may be doing more harm in the long run.

So I am not as opposed to the LTAF as a viable alternative – at least not in principle. But any investors looking to make use of them must do so with their eyes firmly wide open.

Dzmitry Lipski, head of funds research at interactive investor, perhaps put it best this week. While respecting the “huge effort” it has taken to come up with LTAFs, he said: “But this is an untested model and we still struggle to see how the structure will solve the liquidity issue. So while we watch and wait, we still wish the structure the very best as it gets off the starting line, because it is investors who are the ones at risk of injury.”

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