Liquidity matters in fund selection

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• Understanding liquidity risk is key to fund selection
• We contrast liquidity profile of different fund formats and strategies
• Active funds require most scrutiny as holdings are idiosyncratic

 
Whereas there is no shortage of analysis on the risk and return of active and index-tracking funds alike, there is less detailed analysis on liquidity risk.  Liquidity risk is a key aspect of Product Governance for advisers, and liquidity problems have been the underlying reasons for gatings (the suspension of client dealings) of high-profile funds in equity, bond and property asset-classes.
We explore the importance of liquidity in fund selection, and considerations when contrasting formats, strategies and evaluation metrics.

For retail investors, access and liquidity are essential.  We strongly believe that when building portfolios for retail investors, there should be a strong preference towards highly liquid funds, so that – simply – investors can get their money back if they need it.

This is why in portfolios we designed for wealth managers and advisers in 2016, we advocated to use property security ETFs, rather than property funds, which was subsequently vindicated by the Brexit-related gatings in 2016 and 2020.

This is why we advocated – in 2019 – that investors were concerned about bond liquidity, they should stick to Bond ETFs. This was based on insights we learned from the yield spike in 2017 that saw liquidity in high-yield bonds dry up, and highlighted the same issues as property funds faced.

This is why we advocated – in 2020 – that when constructing alternative asset class exposures within portfolios, advisers would be safest to stick with liquid versions of those alternative asset exposures.

And finally, this is why, when it comes to looking at active equity funds, we study the liquidity profile (redemption horizon) so carefully.  We want to help advisers we work with to “avoid” the next Woodford – not just from a performance perspective, but from a liquidity perspective too.

As we move from an era of accommodative liquidity (quantitative easing) to a gradual reduction in liquidity (quantitative tightening), understanding the liquidity profile of funds and portfolios is key.
This is more than a box tick for product governance.  It is an essential protection of client best interests.

Register you interest in receiving our liquidity analysis white-paper (for UK advisers only)

Register for our CPD webinar on Liquidty Risk and Fund Selection