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Square peg in a round hole

27 January 2020

AIC issues report on the dangers of holding illiquid assets in open-ended funds.

Today the Association of Investment Companies (AIC) has issued a new report, Square peg in a round hole, which examines the dangers of holding illiquid assets in open-ended funds. The report explains the AIC’s solution to this problem, reliable redemption, and calls for urgent action from regulators and policymakers to tackle systemic risk in the financial system.

Ian Sayers, Chief Executive of the Association of Investment Companies (AIC), said: “The failure of the Woodford Equity Income Fund and the suspensions of several open-ended property funds in recent years have justifiably damaged consumer confidence in the funds sector. These problems have arisen because of foreseeable failures of product design and inadequate regulation.

“When open-ended funds invest in hard to sell assets but offer daily redemption there is a fundamental liquidity mismatch. Like a square peg in a round hole, daily redemption and hard to sell assets just do not fit together. It is this mismatch that threatens financial stability. The worst case is a vicious cycle of redemptions leading to further fund collapses and declining asset values.

“This report calls on regulators and policy makers to take urgent steps to protect the financial system. As we’ve learned from previous financial crises, it’s much better to prevent problems building up than to try and tackle them after the event. Rather than ban open-ended funds from holding illiquid assets, as some have suggested, our solution is reliable redemption, which matches redemption notice periods to how long it takes to sell the underlying assets.”

The AIC’s solution: reliable redemption

The AIC believes that all open-ended funds should be required to offer reliable redemption to match the redemption terms of the fund (the promise made to investors as to when they can get their money back) to the liquidity of the underlying assets (the time taken to sell holdings without a fire sale).

Reliable redemption means:

  • The basis on which an investor can leave the fund (in timescale, volume or price) should not change, irrespective of the level of redemptions;

  • Redemption processes must not rely on assets being sold cheaply to raise cash to meet redemption requests;

  • Redemption arrangements must operate in both normal and foreseeable stressed market conditions.

Read the full report here

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Notes

  1. The Association of Investment Companies (AIC) was founded in 1932 to represent the interests of the investment trust industry – the oldest form of collective investment.  Today, the AIC represents a broad range of closed-ended investment companies, incorporating investment trusts and other closed-ended investment companies and VCTs. The AIC’s members believe that the industry is best served if it is united and speaks with one voice. The AIC’s mission statement is to help members add value for shareholders over the longer term. The AIC has 363 members and the industry has total assets of approximately £202 billion.
  2. Disclaimer: The information contained in this press release does not constitute investment advice or personal recommendation and it is not an invitation or inducement to engage in investment activity. You should seek independent financial and, if appropriate, legal advice as to the suitability of any investment decision. Past performance is not a guide to future performance.  The value of investment company shares, and the income from them, can fall as well as rise.  You may not get back the full amount invested and, in some cases, nothing at all.
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