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In February 2021, fund manager Neil Woodford made headlines by announcing a comeback to money management. It has been met with a cold response from other financial institutions and many of those who used to invest with him.
To quickly recap the story, Woodford used to run a market-beating fund called Woodford Equity Income (now called LF Equity Income). It held a large number of unlisted or illiquid assets which produced stellar investment growth, but eventually met poor performance and investor flight in 2019. As a result, the fund was suspended as it fell to a low point of about £3bn (down from its £10bn+ high). Nearly a year and a half later, many investors are still waiting to be compensated as the fund struggles to sell these assets.
It’s a hard lesson about investment liquidity and why it is important for a portfolio. In this post, our Liverpool-based financial planning team will be sharing some thoughts on what liquidity, how it works and what this means for an investment strategy. We hope this informs and inspires your thinking, and we invite you to get in touch if you’d like to discuss your own investments with us. You can book a free, no-commitment consultation below.
What is investment liquidity?
Imagine you wish to sell your house. How easy would it be? Of course, it partly depends on how attractive your property is to potential buyers, as well as the asking price. Yet there are also lots of factors outside your control, such as the number of potential buyers and the state of the UK housing market as a whole. Even with a buyer lined up, however, it can take a while to sell your property to them as you both comb through the necessary inspections and paperwork.
As such, residential property – despite its benefits – is commonly seen as quite illiquid. Liquidity, in simple terms, refers to the amount of time and difficulty involved with transforming an asset (e.g. a house/flat) into cash. The latter, itself, can be quickly turned into another asset because it is highly liquid. I.e. You could quickly buy, say, a fund of stocks or bonds with cash (or, indeed, another property!) due to its ease of access and transfer.
Why is liquidity important?
You may have heard the expression: “Asset Rich, Cash Poor” to describe many middle-income families in the UK. This refers to people who are fairly wealthy, on paper, due to having a decent sized pension, valuable possessions (e.g. jewellery) and a highly-valued home. Yet with regards to cash savings in the bank, the volumes are quite low. Some households may have little to no emergency fund at all, living paycheque to paycheque – putting their overall financial stability at risk. Should you need to access a large cash sum quickly, this would present huge difficulties.
A similar thing can occur in an investor’s portfolio, or even in an individual investment fund (such as the aforementioned Woodford Fund). Suppose, for instance, that you are invested in a fund which pools lots of investors’ money into various UK property investments (remember, property is generally quite illiquid). Moreover, imagine that, suddenly, lots of the fund’s investors quickly wanted to pull their money out, perhaps due to recent alarmist headlines about an imminent UK housing market crash. This would put pressure on the fund’s managers to sell many of its more liquid assets, so they can quickly pay these investors. However, doing so would decrease the financial stability of the fund. Similar to the “Asset Rich, Cash Poor” household, the fund would suddenly find itself in a precarious position. If more investors then wanted to also sell and get their money out, at this point the fund might even collapse.
Liquidity is important, therefore, to help ensure that your investments continue to grow over the long term – protecting them from collapsing within a vortex of investor panic-selling. Yet it also matters for your own financial security and planning in unforeseen circumstances. For instance, if you suddenly get diagnosed with a terminal illness, you may wish to sell your investments and enjoy the cash while you are still alive. If they are tied up in illiquid assets, however, then it may be difficult to achieve this. By the time you can access the money, it may be too late.
Implications for an investment strategy
From here, we imagine it is fairly clear what this means for a portfolio – regardless of whether it is “adventurous”, “cautious” or otherwise in its risk profile. In short, it’s important to ensure that your portfolio is appropriately diversified across different investments, markets and asset types. Not all of your investments need to be highly liquid, but it is wise to consult your financial adviser about ensuring that a good number of them are – in case they need to be sold fairly quickly (e.g. to help pay for the cost of long term care).
Are you interested in talking to a financial adviser about your savings and investment planning needs? We’d love to assist you here at Hanson Financial Services.
Please contact us to arrange a consultation with our team – free and without obligation – to gain more clarity and peace of mind over your financial plan.
You can call us on:
Liverpool Office: 0151 708 7616
Manchester Office: 0161 401 0991
Chester Office: 01244 960 039Or email via: [email protected]