June 10, 2019

Monday Morning Memo: Fund Closure – The Hidden Risk of Mutual Funds

by Detlef Glow.

The news about the closure of the Woodford Income Fund hit the U.K. fund market quite hard—and a number of market observers made this event big news—but the reality is the closure of a fund is nothing unusual. This kind of corporate action happens frequently and is a protection mechanism which is stated in the fund prospectus.

From my perspective, the Woodford case showed once again that investors have to read the prospectus carefully and need to consider the general risks, as some of these risks tend to happen more often than one would expect. That said, the closure of a fund due to high redemptions is a risk for those who want to redeem shares in the respective fund, but is a protection mechanism for those who want to stay invested. A closure period helps the fund manager to gather cash to meet redemptions without being forced to sell securities he may have wanted to keep or which do not have a proper valuation due to a lack of liquidity or other market events. The ability to do this protects the remaining investors because the fund manager might be able to meet the cash demand without impacting the remaining assets or the implemented investment strategy.

With regard to this, investors and fund selectors might need to take new routes within their selection processes, as we witness a lot of herding behavior in the fund market leading to massive inflows in some funds. If for some reason the inflows turn into outflows, it can often be observed that these outflows are much faster than the inflows. This is because institutions tend to invest in several tranches until they reach their target allocation, but sometimes they sell all their shares in one move if they change their view on the respective fund or their asset allocation. This means that it might pay off for fund investors to look for boutique funds, because these products are often overlooked by larger institutions. One reason for this could be that the assets under management of the respective fund might not fit the needs of these institutions. Another reason could be the fund management company does not have a large sales team or does not do the respective marketing exercises of a larger asset manager to promote the sales in their funds. This can be true in some cases where the fund performance might be as good as, or in some cases better than, the performance of their larger peers.

The views expressed are the views of the author, not necessarily those of Lipper or Refinitiv.

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