Fund Industry Developing ‘Lock In’ Products To Guard Against Mass Withdrawals Sparking Liquidity Crisis

The scandal that has embroiled Neil Woodford’s Equity Income Fund as a result of his decision to close the doors to stave off a liquidity crisis as investors stampeded for the exit might well be answered to a new breed of fund designed to prevent similar situations happening again. A special taskforce set up by the trade body of the Investment Association, made up of investment funds and the Treasury, has been working for on proposals to develop a new type of fund referred to as a “long term asset fund”.

Woodford’s fund is heavily invested illiquid stocks and experienced a severe liquidity crisis after poor performance led to high numbers of investors losing patience and moving to sell out. Funds like the Woodford Equity Income Fund are only permitted to have 10% of their holding in privately held companies so holdings can be easily sold if investors want to leave. Woodford’s fund met this requirement but because he asked many of the companies he wanted to invest in to list on the Guernsey Stock Exchange, which has low liquidity, as a prerequisite for his investment. So when too many investors wanted to cash out, the fund was unable to find buyers for the stock leading to a liquidity crisis.

The new fund model might seem like a direct response to the recent controversy that former star fund manager Woodford’s bolting of the doors has led to. However, it has actually been in the works for around a year. The idea was a new model that would both help keep the UK’s fund sector competitive after Brexit but also encourage investors to take a long term view and not be tempted to cut their losses, realising an on-paper loss, during times of stock market volatility and bear markets.

Liquidity risk is a particular problem of open-ended investment funds like the Woodford Equity Income fund. The structure means the fund has an unlimited cap on total assets because it buys more shares as new investors buy into the fund and sells them again to pay them back when they want to leave the investment. Investment trusts have a different structure, which is similar to that of a stock market listed company. They issue a fixed number of shares that investors buy and sell over a stock exchange, with their price rising and falling based on demand, which is influenced by the fund’s performance.

The new fund model being developed would also still be open ended buy with the restriction that investors would only be allowed to cash out during pre-agreed windows over the year. The Investment Association’s chief Chris Cummings commented:

“The UK is crying out for these types of long-term investments . . . which will help savers and local communities up and down the country….With the UK set to leave the EU in the next few months, these proposals will help future-proof the UK’s investment landscape, ensuring it can remain competitive on a global scale.”