Psigma CIO Tom Becket warns on risk to giant corporate bond fund liquidity if sentiment turns suddenly

3rd June 2013

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It probably depends on how much you need the money, but if you are invested in something which then places restrictions on your ability to cash it in, then you need to be aware of that risk among all the other normal investment risks you are taking. But what if that risk exists where you didn’t expect it?

Of course, many investors invest in illiquid assets and understand exactly what you are doing. Along with other considerations, you may take a risk that for a period of time, you won’t be able to cash in on the investment. If it is only a portion of your portfolio, then that may make it more acceptable. Yet those restrictions may also coincide with that particular market or asset doing badly, an unexpected number of investors cashing out or both. We saw this phenomenon with a few commercial property unit trusts, which invested directly into property rather than shares, and which had to prevent investors from cashing out at least temporarily in 2008/2009. To help understand what happened consumer website Which? explains the different types of property funds on its website here. Yet it may not have done too much permanent damage. All financial advisers would say that you need access to at least three months worth of household outgoings in readily accessed cash. Most professional investors understand that too. But, that said, there was a definite feeling at the time, that some investors had not understood the nature of the product – commercial property being famously illiquid. Some investors were caught out, certainly given the subsequent volume of protests.

Now the chief investment officer of Psigma Tom Becket says his firm is avoiding some types of exposure due to liquidity fears. But Becket is not talking about the usual areas where liquidity might be a concern traditionally such as small cap funds or some specialist investment trusts. He is referring to giant corporate bond funds. We include Mr Becket’s full note elsewhere on Mindful Money today but here is the key quote below.

He says: “We are currently extremely worried about some of the behemoth corporate bond funds, which have grown to a huge swollen size and might not be able to provide the liquidity that investors expect, were the sentiment towards the asset class to change quickly. We would advise that an investor should never hold more than 10% of a balanced portfolio in assets that are non-readily realisable,” Becket says.

Psigma is practicing what it preaches. It holds only two funds that do not trade daily and they make up around 4 per cent of the portfolio. But if a big multi-asset fund manager is doing this, it could have huge implications, providing Mr Becket is correct. Very many retail investors will be invested in giant corporate bond funds, but they may not expect restrictions on encashing them whatever the climate. We think it is at least worth asking your financial adviser, if you have one, or your fund manager about the risk of liquidity constraints. We also wonder what the regulator would do in such an instance? We will bring you some more views on this later this week.

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