Jeff Prestridge: I love funds, but not these ones

There are lots of great funds out there, but some are not fit for purpose. Our columnist reveals the ones he thinks you should avoid like the plague.

I love unit trusts and open-ended investment companies. Over the years, they’ve opened up the world of investing to the general public, empowering people to build long-term wealth for themselves and their families, preferably inside tax-friendly ISAs and pensions (self-invested personal pensions).

Hip hip hooray, I say, 10 times over. Twenty hips, 10 hoorays.

But in the rush to empower (and make profits), some fund management companies have put together trusts and Oeics that are just not fit for investor purpose. As a result, there are a minority of funds that should be avoided like the plague by investors. Caveat emptor 20 times over.

I don’t want to get too technical on you, but the structure of trusts and Oeics just does not lend itself to the holding of illiquid assets. By illiquid, I mean assets that cannot be sold in a hurry – for example, office buildings, industrial units and unlisted, unquoted shares.

Why is this the case? Well, it’s because trusts and Oeics are set up on an open-ended basis. This means that when a fund is being hit by big redemptions (more investors wanting their money out than new investors wishing to put money into the fund), assets usually have to be sold to generate the cash to pay off those investors rushing for the exit door.

If the assets are illiquid, then fulfilling those redemption requests can present a big problem, occasionally a catastrophic one. It’s what did for investment fund Woodford Equity Income nearly three ago when a big investor in the shape of Kent County Council wanted its money out in a hurry. The fund simply did not have sufficient liquid assets to meet the council’s redemption request, culminating in its suspension and ultimate winding down. Indeed, there are fund assets that have yet to be sold.

But on a far wider scale, illiquidity issues have plagued commercial property funds for years. Managers of these funds have suspended dealings more times than former hardman footballer Vinnie Jones got suspended for getting red cards on the pitch during his illustrious career for various clubs (the likes of Wimbledon and Leeds).

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Whenever a ‘crisis’ has befallen the nation (be it 2008 or 2016 post the EU vote), property funds have shut up shop. The last crisis was lockdown and it did for some property funds. Aviva gave up the ghost on its UK Property and its UK Property Feeder funds last July, while the £1 billion Janus Henderson UK Property fund is currently in wind up.

According to data just released by the Association of Investment Companies (AIC), open-ended (direct) property funds had assets under their belt of £22 billion five years ago. Once Janus’ fund is wound down, the belt will be a slimline £8 billion. Further slimming is guaranteed.

Although the regulator, the Financial Conduct Authority (FCA), is looking at ways of addressing the problems that illiquid open-ended funds face when a deluge of investors want to run for the hills, they are doomed to fail. The sooner the regulator cottons on to that, the better. Illiquid assets just do not belong in unit trusts or Oeics. Full stop, end of matter.

The solution is a simple one. Ban the holding of illiquid assets by unit trusts and Oeics. This will then ensure that any investor looking for exposure to commercial property or unquoted companies will turn their attention to stock market-listed investment trusts. Trusts whose shares will always be able to be traded by investors irrespective of catastrophic economic events – and whose assets do not have to be offloaded as a result of investors wanting out. It’s the share price that takes a battering.

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For example, monster investment trust Scottish Mortgage (LSE:SMT) has a quarter of its £15 billion of assets in private (unlisted) companies. Yes, its shares have taken a pounding in recent weeks (down 13% over the last month) as a result of fears of a global economic slowdown, geopolitical tensions and tech shares being marked down sharply. But investors can still buy and sell the shares and the trust’s assets remain very much intact.

Richard Stone, the newish head of the AIC, has been opining on property investment trusts this week. He said: “Investors who still want exposure to property should consider property investment companies which have a robust, proven structure and track record. During times of market stress, you can expect the share price to fall, but the fund manager is under no pressure to sell the underlying assets to meet redemptions, and the shares are tradeable whenever the stock market is open.”

In response to those words, I say: Hip hip hooray. Ten times over.

Jeff Prestridge is a freelance contributor and not a direct employee of interactive investor.