Fund liquidity flaws
Why Monthly and Daily Fund Liquidity Hurts Returns
The typical fund manager has some very common traits. Fund structures are similar, fee structures are similar, reporting conventions are again, similar.
We started our fund in 2009, liquidity was at the forefront of investors minds given the amount of gating that went on during the financial crisis. Gating is used by managers to suspend redemption requests when they believe asset prices and markets are not reflecting fair value. This stops assets being liquidated at depressed prices that are harmful for fund performance and investors. Buying a fund that has quarterly liquidity and then be told that you can't have your money for 6-12 months doesn't quite sit well with investors. Quarterly liquidity was common in hedge funds at the time. We decided on a monthly application and redemption cycle meaning you could come and go in our fund on the first of every month. We thought this was a highly liquid fund compared to other hedge funds.
During the last 10 years there has been a strong push, particularly in retail funds, toward daily Net Asset Value (NAV) calculations. The rationale being that financial planners can execute a portfolio on the 4th of a month without having to wait for a month end NAV to apply for a particular fund.
Managers always say that permanent capital is the holy grail. And people like Warren Buffett have actually achieved it. One could argue Soul Patts in Australia is similar. Australian fund managers have attempted some permanent capital through Listed Investment Companies (LIC) but if you trade at a discount to NAV long enough, Geoff Wilson will turn up and kick you out as the manager. Why is permanent capital the holy grail? It comes down to investing efficiently and effectively.
When you have to always be mindful that your investors can redeem their funds this month or this week, you have to build a portfolio that provides for that liquidity. It means not having large positions in illiquid stocks. It means that stock you bought that was 2% of the portfolio and is now 20% of the portfolio is not the right holding for your new investor that didn't enjoy the uplift (ISX and LHC et al). It means you can't confidently invest in private companies because they are only periodically liquid and again make it difficult to fulfill investor redemptions.
Managers have been forced towards more and more liquidity but it ultimately effects the ability to provide superior performance.
Further, it means managing that all important monthly NAV number that the entire industry is fixated on. The last day of the month is such an important day. Why? Because a bad print can cause an investor or a bunch of investors to redeem. For example, if your investors are used to a lowish volatility on returns, seeing a down 5% month might be a shock. You need to avoid a down 5% month. Ultimately as a manger you make decisions in a portfolio that are nothing to do with the potential for a particular investment, but how is it going to effect this months performance. I'm sure your fund manager is different though...
Managing only my own money now, I don't even notice. What day is it? Who cares!
Ideally, I think managers should move away from updating performance on 20 odd day cycles. It's a wildly short time frame to measure success or failure. Even companies get 3 months to give performance updates and there is a general consensus that time frame is even too short. But if you're a manager and your fund offers monthly or daily NAV prints, unfortunately you're stuck with it. Its almost impossible to take that away once it is given.
