When we first meet new clients, we like to take them through a presentation of our process so that they can understand how we manage their portfolios and what to expect over time. At the beginning of this presentation, we briefly discuss the importance of things like costs, transparency, alignment of interests and liquidity. While most of our presentation is dedicated to process, these 4 points are extremely important when assessing a potential/existing investment, and are often underappreciated and misunderstood by investors.
Liquidity in particular is something few investors really understand and only learn to appreciate when they need to access their money. Imagine being invested in something for years and earning good returns on paper, only to learn that you cannot realize these returns when you ask for your investment to be redeemed. There are many reasons this could happen: Lock-ins, no active secondary market, illiquid underlying assets, etc.
Perhaps one of the most significant casualties of the Brexit vote so far has been the UK property market. The UK REITs index (i.e. listed property) has dropped by nearly 30% in USD terms since 23 June. REITs are generally quite liquid because they are listed on a stock exchange and so there is an active secondary market. Physical property and unlisted property investments on the other hand are far less liquid, which can result in problems when investors need to access their funds.
An example of this has become apparent in the last few days as 3 well-known UK property funds have had to suspend redemptions because of insufficient liquidity: Standard Life, Aviva and M&G Investments have all suspended redemptions from their property funds so that they can liquidate their underlying assets in an orderly fashion. Unlike listed REITs where investors can sell their units into an active secondary market, these funds have to fund redemptions from their underlying assets. Because their underlying assets are properties they usually take time to liquidate (it’s not so easy to find a buyer for an office block or a mall, especially now in the UK). Usually redemptions aren’t an issue for these funds because their investors aren’t all liquidating at once, but when redemptions peak they simply can’t satisfy them all at once.
The same problems can arise in hedge funds with complex structures that take time to unwind, and with private equity funds that have highly illiquid holdings in unlisted private companies. These funds usually feature lock-in periods and/or notice periods, though they have also been known to trigger suspension clauses in a number of cases.
Liquidity then is a critically important consideration when making any investment – something many investors only discover too late, and to their detriment.
That’s not to say that these funds can’t be good investments – they can – it’s just important that investors understand the liquidity profile of their investments upfront, so that they can make sure they have sufficient liquidity in their overall investment portfolios.
Our clients’ portfolios are only invested in highly liquid listed assets with very active secondary markets. They are free from complexity and are completely transparent. This means that liquidity risk is very low.