Managing liquidity 

I have been having some interesting conversations with a particular branch of Regulation, which will remain nameless, about the critical impact of liquidity when it comes to understanding, reviewing, and generally assessing the risks and prognoses associated with...um...certain kinds of investment funds.  The topic for the conversation was an unregulated fund, domiciled outside of the UK regulatory system, where the entire 'value' of the proposition was 100% wrapped up in the fund-manager's ability to exit by divesting itself of a property development.

Yes, it was that kind of fund, one where the investor had to wade his or her way through an almost endless series of disclaimers and warnings before they could get to the point of signing their lives away.  No collective model here:  once the investor had purchased his shares, he or she had no rights to anything until the Magic Moment when liquidity would be achieved.  The whole framework for this kind of investment embodies the very worst connotations of the word 'speculative', and whilst I may have led an innocent and protected existence, I cannot think of a single client I have met over the last thirty-seven years who would have wanted anything to do with this kind of stuff.  In fact, as I have, unfortunately, had to review the literature, the words caveat emptor have been ringing eerily in the corridors of what passes for my brain these days.  With some kinds of investment, you have to conclude that there is an elevated probability of it all ending in tears:  scanning this paperwork leads one to the conclusion that there is an inevitability of precipitation.  The only imponderable is how long it will take to get to that point.

It's entirely conceivable that the IFA in question had cornered the market in investors whose attitude towards risk was so relaxed that they were essentially comatose.  It is also, I suppose, possible that there are investors out there who can only find satisfaction and meaning in life if they continually face the prospect of financial annihilation.  Thankfully, the Good Lord has protected me from such individuals - for, as we have come to learn, these are the same people who suffer from a very specific form of amnesia about past events when it comes to pursuing redress with those who love to rubber-stamp such things.  And, it has been intriguing...no, perplexing...alright, downright frustrating, to see the regulator placing great stress on irrelevant, contrived and (frankly) misleading interim valuations, when, really, the entire action focuses on liquidity events.

It's always been about liquidity.  AIM portfolios are notoriously illiquid.  Shares in smaller companies may easily experience restricted trading.  Emerging markets stocks may be affected by changing valuation bases.  The kinds of synthetic assets which get grouped under the heading of 'alternatives' are hardly likely to supply a 'free liquid lunch' for those who are concerned about such matters.  Even shifting funds from a deposit account paying 0.01% to a cautiously-managed stocks and shares ISA is going to present implications for access and liquidity.

And, as we all know at the present time, Commercial Property certainly does have its moments.  Mind you, there's nothing new to that topic - we've seen exactly the same dynamics pan out, time and time again, over many years - and that hasn't stopped Commercial Property from being a viable asset within a carefully-constructed asset-allocation model.  The mere 'fact' of illiquidity (or the potential thereof) is not the important issue:  what really matters is how we handle it.  With certain examples (the unregulated example mentioned above), the way you handle it is to run screaming in the opposite direction.  With others, you might assess the pros and cons, you might make provision elsewhere for liquidity where it matters, and you would certainly diversify as much as makes sense, given what you know of the client's circumstances.

And, of course, you'd take steps to ensure that your clients are educated as far as possible, so that they fully understand the consequences of their own investment decisions.
 

Kevin Moss, 09/07/2020