A broken record

Another day, another open-ended investment fund holding illiquid assets has been forced to shut up shop. The £2.5bn M&G Property Portfolio fund has suspended withdrawals amid a rush of investors to take their money out. It is only a matter of months since Woodford Equity Income felt compelled to do the same.

The M&G crisis may be the straw that breaks the camel’s back for regulators, forcing them to intervene. The financial watchdogs surely can’t continue to allow funds like these to take investors’ money when it’s abundantly clear that many investors have little idea about what might happen.

To be clear, property – even the retail property in which the M&G fund is heavily invested – can be an excellent investment. So too can the unquoted companies in which Woodford Equity Income had such big holdings. It’s just that these funds are a completely inappropriate way to access such assets.

It’s a straightforward structural problem. If the number of investors wanting to take their money out of an open-ended fund is greater than those who want to put cash in, the manager has to pay them out of the fund’s cash reserves. Once they run out, the fund has to start selling assets to cover redemptions – that’s fine if you’re talking about highly liquid assets such as shares traded on a recognised stock exchange; but much less so with illiquid assets such as property, unquoted companies and many others, which are harder to sell quickly for a fair price.

This isn’t rocket science. These suspensions happen time and again – it’s only a couple of years since a whole swathe of open-ended property funds were forced to close for a period as investors rushed for the doors in the wake of the Brexit referendum.

The mystery is why advisers would ever suggest investors put their money into these vehicles in the first place. It’s not just that there’s a risk of being prevented from getting your cash out for an extended period, but also that in seeking to mitigate this risk, the fund manager has to stick a chunk of your investment into an asset class with no chance of delivering decent returns. Several of M&G’s peers have reassured their investors that they won’t need to follow its example because they have such a sizeable element of their portfolios in cash. That must come as a surprise to investors who put their money into these funds because they wanted exposure to property - and have been paying charges on that basis.

The really frustrating element of these Groundhog Day stories is that advisers and investors who want exposure to these asset classes have at their disposal a much better option than an open-ended fund. In property and unlisted equities, as well as asset classes such as infrastructure, hedge funds, forestry and more, investment companies offer all the advantages of the collective fund approach, without the downside of the open-ended structure.

In an investment company, of course, the issue of managing inflows and outflows simply never occurs. Investors who want into the fund buy its shares on the stock market, which operates as a liquid marketplace for both buyers and sellers of the company. If more sellers want out, the investment company’s share price will take a hit, but there’s no need to start selling the underlying assets.

For years, some advisers have worried about the “complexity” of investment companies, pointing out that demand and supply for their shares can get out of sync with what’s going on in the underlying portfolio. This is when the fund’s shares trade at a substantial discount or premium to the underlying value of its assets. But this is surely better (and less complicated) than the open-ended alternative, where investors may not be able to get their money back at a time of their choosing, at any price at all.