David Prosser discusses liquidity in the investment company sector.
There’s no doubt that investment companies appeal to a much wider audience in this post retail distribution review environment – sales of closed-ended funds to financial advisers and their clients continue to climb higher. But there are some advisers who remain nervous about certain aspects of investment companies – notably, they question whether there is sufficient liquidity in the sector.
It’s not an unreasonable concern. Private investors should very rarely have trouble placing an investment company deal, even in the smallest fund, though prices may vary. By contrast, advisers buying or selling shares in bulk on behalf of groups of clients might have more reason to be anxious.
The general counsel to advisers and investors with such worries has typically been that with funds above a certain size threshold, there are unlikely to be liquidity issues. Some advisers look for investment companies with a market capitalisation of at least £100m – others feel £150m is a more appropriate minimum.
However, an interesting feature in the latest issue of Citywire’s Investment Trust Insider magazine suggests advisers worried about liquidity take a slightly more sophisticated approach than simply looking at the market capitalisations of funds. For one thing, some large funds have family shareholders with very large stakes – the free floating shares of such funds may therefore be worth much less and liquidity may still be lacking. Moreover, the magazine points out, even large funds sometimes trade on wide bid/offer spreads, which makes trading in their shares expensive.
“The bid/offer spread is perhaps the most valuable measure [of liquidity], as it indicates the true cost of trading and helps identify any anomalies,” Citywire suggests.
In practice, there are a variety of metrics that financial advisers can use in order to assess the liquidity of a fund. Market capitalisation is one important measure – Numis Securities says that of the 434 investment companies it monitors, 279 are larger than £100m – but so too is trading volume; that is the value of shares in a fund sold in a typical day. The AIC publishes trading volume data for investment companies on its site. This data includes the value of shares traded yesterday and the value traded over one month, one year and five years. For funds worth more than £100m, an average of £950,000 of shares were traded each day over the past year according to Numis.
Then it’s back to the bid/offer spread. The average spread over the past month on an investment company worth more than £100m has been 1.2 per cent, against 9.5 per cent for funds worth less than £50m. But don’t make any assumptions – just as there are a number of large investment companies on wider spreads, many smaller funds trade more narrowly than the average.
Investment companies can also do their bit to ensure liquidity is strong. For example, share buyback programmes will ensure there is a market for a fund’s shares at times when demand appears to be less strong.
The bottom line is that there are sizeable numbers of investment companies where no investor – even the largest financial adviser – need worry about liquidity. These funds are available at very competitive costs. Numis, for example, lists 20 investment companies currently offering a bid/offer spread of 0.4 per cent or lower – it includes well-known mainstream funds such as City of London, Perpetual Income & Growth and Schroder UK Growth, as well as more exotic options such as Templeton Emerging Markets and BB Biotech.