Suddenly the alternative assets world has become much more difficult. Three fund management companies, GAM, Woodford and H20, have scared the little cotton socks off investment committees, prompting an outbreak of extreme caution.


These three funds all experienced difficulties when it became clear they’d been buying deeply illiquid stocks and bonds – and couldn’t sell them when the demands for money arrived.

As a result, our risk management team have been asking deep and meaningful questions about the portfolio: “Nap, just how liquid are these equity stubs in the commodity trade finance deal?” one of the bright young things asks me. I respond:

“On a scale of 1 is water and 10 is set concrete, these will be about a 12. But we knew that when we bought them. We agreed the returns fairly compensated the risk and they were money good. We live with them.”

‘On a scale of 1 is water and 10 is set concrete, these will be about a 12’

She asks me to explain what situation would cause them to cease being money good. I respond with some thoughts about a good old-fashioned trade war where China stops buying any raw materials and the lights go out everywhere. And since that’s unlikely to happen, we hold them and take the 22% return for the next three years. This particular fund is set up to do that.

Other funds are not so fortunate, especially when they’ve been structured to fit ill-conceived European rules, promise daily dealing and guarantee the opportunity to exit the fund at any time – which will be kind of difficult when markets go into lockdown.

The result has been predictable: the Financial Conduct Authority is tumbling over itself to promulgate new rules to ensure unds aren’t forced to ‘gate’ because of illiquid instruments.

The Bank of England is warning funds about the dangers of illiquidity, and investment committees are slamming the door on anything that sounds even slightly challenging.

Wonderful – the new rules will mean the only thing funds are allowed to buy is supposedly liquid government bonds … and since most of them are negative yielding, that bodes very badly for pension expectations.

‘You can regulate anything, but you can’t make stupidity illegal’

It’s a massive overreaction to the difficulties of GAM, Woodford and H20. Each of those situations was quite different.

GAM made a series of investments in bonds arranged by Greensill which included some very curious lending to an Indian company to buy an aluminium smelter in Scotland, and financing jets operated by a Russian-owned airline – which the fund manager seems to have missed when doing his due diligence.

Neil Woodford was buying small illiquid stocks because he couldn’t find returns in the liquid market.

And no one is quite sure why French fund H20 was so willing to lend to companies controlled by a German entrepreneur with a colourful past. You can regulate anything, but you can’t make stupidity illegal.

‘greedy investors put their concerns to one side and pile in and buy bonds issued by ultimately worthless companies’

Long-term low interest rates, and the expectation they will go lower yet, have been the most important market driver for many years.

They create massive risk – investors are forced to dig deeper to obtain any kind of meaningful returns. As a result, we now have euro-denominated junk bonds trading at negative yields. I wonder how liquid they will be when the crunch comes?

That’s a rhetorical question, but I’ll tell you the answer anyway: they’ll be about 15 on my illiquidity scale.

The danger is that as investors dig ever deeper for returns, they buy less and less liquid securities. The result is that illiquidity becomes a growing market threat. It scares away investors.

In the institutional market, alternative investments – from venture capital funds to debt private placements – are all assumed to be illiquid.

The assumption is that buyers understand exactly what they are investing in and plan accordingly. Where it breaks down is if investors buy something without due diligence, or conveniently forget they’re the only investor and expect the dealer to bail them out. If you are a holder and you panic, then you inevitably get burned.

It gets far more dangerous in the retail markets. Individual investors have been persuaded to suspend disbelief by high coupons. When gilts yield 1% and a bond offers 7%, greedy investors put their concerns to one side and pile in and buy bonds issued by ultimately worthless companies.

We see these all the time – and walk away every time. I have precisely zero interest in funding a Maltese property developer who claims to have found a niche building office space in Lithuania.


Napoleon Bonnacord-Smith, first published in The Property Chronicle


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