FCA’s Mistaken Policy over Long-term Asset Funds

The Financial Conduct Authority (FCA) have released a “policy statement” containing proposals for new long-term asset funds and their regulation. See PS23/7 (https://www.fca.org.uk/publications/policy-statements/ps23-7-broadening-retail-access-long-term-asset-fund ).

The plan is that distribution of these open-ended funds will be extended to mass market retail investors. Self-select DC pension schemes and Self-Invested Personal Pensions (SIPPs) will be able to invest into an LTAF. 

The LTAF is a new category of authorised open-ended fund specifically designed to invest efficiently in long-term, illiquid assets. Illiquid assets include venture capital, private equity, private debt, real estate and infrastructure. The FCA claims that they can provide a useful alternative investment opportunity for consumers able to bear the risks of such investments. They also say that “an ability to invest in long-term illiquid assets, through appropriately designed and managed investment vehicles such as the LTAF, is also important in supporting economic growth and the transition to a low-carbon economy”. But don’t private equity investment trusts already provide this?

This is surely an accident waiting to happen, particularly as it is proposed to exclude such funds from the Financial Services Compensation Scheme (FSCS).

The FCA also states that “While these investments can have a higher risk of loss than diversified portfolios of listed equities or bonds, they can also potentially deliver higher long-term returns in exchange for less liquidity”. Where is the evidence for this? Selling illiquid investments to retail investors via open-ended funds is a recipe for mis-selling claims and significant losses as we have seen with some property funds for example.

The AIC has come out strongly opposed to these proposals – see their press release here: https://www.theaic.co.uk/aic/news/press-releases/selling-ltafs-to-retail-investors-could-prove-to-be-a-mistake . To quote from it: “As the underlying assets are hard to sell investors run the risk of being trapped in the fund in stressed markets. It could cause significant hardship if investors cannot access LTAFs held in pensions. The additional measures proposed by the FCA do not go far enough to secure reliable redemption and prevent these problems emerging”.

Has the FCA consulted experienced private investors before proposing these measures? Or is it being supported solely by financial institutions wanting to sell more such funds?

The proposed regulations of LTAFs are very complex and are unlikely to be understood by private investors while it is not even clear that they will qualify for ISAs.  

Private investors should respond to the FCA’s public consultation on these proposals – available from the first link above.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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NMC Health Attacked and Open-Ended Funds Holding Illiquid Assets

Yesterday Muddy Waters, the same organisation who recently attacked Burford Capital, published a highly negative report on NMC Health (NMC). The share price fell 33% on the day. Muddy Waters, and owner Carson Black, are effectively saying the accounts of NMC are fraudulent. A quick review of their report suggests the key issues are undisclosed related-party transactions, the purchase of assets at wildly inflated prices and the under-reporting of debt.

As with other similar “shorting attacks”, the dossier is long and complex enough to make any quick analysis of whether it is all true, or whether some of it is true, or whether the whole thing is a fiction, impossible to resolve. NMC published a fairly brief statement this morning saying the company had already responded in the past 12 months to many of the allegations but they suggest the claims are “unfounded, baseless and misleading, containing many errors of fact, and will respond in detail in due course”.

NMC run hospitals and other healthcare services in the United Arab Emirates (UAE) and elsewhere. It is registered in England and holds its AGMs in London.

This is what I had to say about such shorting attacks in a previous article: “One of the problems in most shorting attacks is the mixture of possibly true and false allegations, which the shorter has not even checked with the target company, along with unverifiable claims and innuendo. The shorter can make a lot of money by such tactics while it can take months for the truth or otherwise of the allegations to be researched and revealed. By which time the shorter has long moved on to other targets. Shorting is not wrong in essence, but combining it with questionable public announcements is surely market manipulation which is covered by the law on market abuse”.

I still think those who publish allegations that are likely to move share prices should at least give the company the opportunity to comment on the accuracy of the allegations before they publish. A few days grace should suffice with possible suspension of the shares until the allegations are investigated by the company and the FCA.

Readers will no doubt be aware of the problem of open-ended investment funds holding illiquid assets such as property or private equity shares. Investors of funds can sell their shares on a daily basis, but the fund manager who has to meet such redemptions cannot sell the assets of the fund to do so in any sensible time frame. They may hold some cash but if a stampede for the exit occurs then they cannot hope to meet the demand and hence have to close the fund to redemptions.

The Bank of England have published a Financial Stability Report that suggests such funds are creating a systemic risk and unfair outcomes for investors. They make various suggestions to solve the problem which includes making redemption notice periods reflect the time need to sell the required portion of a fund’s assets. For property funds this might mean many months delay. They also suggest a pricing mechanism to impose discounts on those investors who want a quick exit, but that might simply encourage investors to dump their holdings sooner rather than later, thus exacerbating a “run” on the fund.

Are these suggestions workable? I doubt it and they would certainly be confusing for retail investors. Why introduce such complexity when the answer is simply to ban open-ended funds from holding more than a very limited proportion of illiquid assets. Investors have a good alternative in investment trusts which have no such problems.

The Bank of England’s Report is present here: https://www.bankofengland.co.uk/-/media/boe/files/financial-stability-report/2019/december-2019.pdf (see page 75 for the coverage of open-ended funds).

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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