The Perils of Illiquid Assets and Liquidity Risk

The need for proper risk management frameworks

Dr Paul Magro, Founder and Managing Director, RiskCap International Ltd
Originally published in the August 2019 issue

Liquidity risk is not important until it is. And then it becomes the only thing that matters.

Fund managers can no longer ignore liquidity risk management. Over the past few weeks we have heard and read the news on Neil Woodford’s Equity Income Fund and how it ploughed funds into illiquid assets. On 3rd June, the fund was closed to redemptions which left thousands of investors locked in the fund for at least 4 weeks. The issue is not that the fund was investing in illiquid assets – UK funds are allowed to invest up to 10% of its assets in unlisted assets. The issue is did Neil Woodford and his team understand the liquidity risk associated with these assets, moreover, did they have the appropriate liquidity management framework in place in order to facilitate the event of significant redemption risk.

The incident highlights the risks of liquidity mismatches when open-ended funds invest in unlisted assets while offering investors daily access to their money. Mark Carney, Governor of The Bank of England, pointed out that “$30 trillion of global assets are held in funds that promise daily liquidity to investors despite investing in potentially illiquid assets”. Woodford isn’t the first fund manager to run into liquidity problems. In 2016, after the UK voted to leave the European Union, the country’s largest real estate fund froze almost £9.1 billion of assets as investors rushed to get their money out. M&G Investments, Aviva Investors and Standard Life Investments all suspended redemptions from their funds devoted to illiquid property assets. In the US, Third Avenue Management, a mutual fund company founded by Marty Whitman, managed as much as $26 billion in 2006. In 2015, it was hit hard when its Focused Credit Mutual Fund imploded whilst investing in junk bonds.

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