The Financial Conduct Authiority (FCA) warned investors that some asset management firms have “inadequate frameworks to manage liquidity risk”.
In its most recent review of the industry, the watchdog found that “vital” action is needed by asset management firms to ensure investors can safely remove their money.
Not amending these shortfalls could result in investors having their assets frozen if a large amount of money is removed from a fund at once that the firm cannot repay.
Investors famously faced a liquidity nightmare in 2019 when Neil Woodford’s multi-billion fund froze its assets.
The portfolio had a high allocation to illiquid assets, which meant the firm could not pay investors when a large number of them redeemed their holdings at the same time.
Most of the firms reviewed by the FCA had sufficient precautions in place to stop a repeat of this, but a concerning number of asset managers are ill-prepared for potential liquidity issues, which could have “serious risks for investors and to wider market stability”.
Camille Blackburn, director of wholesale buy-side at the FCA, said firms that fail to follow today’s guidance on improving risk management could face intervention.
“This review should serve as a warning to all asset managers that they need to get this right,” she said. “We expect boards to discuss our findings and assure themselves that their firms are not amongst the minority with serious gaps in managing liquidity risk.
“It’s vital the outliers take quick action. They risk regulatory intervention if they don’t take this opportunity to address weaknesses.”
Holding illiquid assets can have its benefits, but investors wanting exposure to the asset class should buy trusts rather than funds, according to Laith Khalaf, head of investment analysis at AJ Bell.
Open-ended funds encounter liquidity issues because redemptions are paid directly from invested capital, whereas trusts do not have to sell their assets to meet investor’s needs.
However, investors who want to avoid the risk of illiquid assets may have little choice, Khalaf warned.
Despite its warnings, the FCA authorised the launch of long-term asset funds in March that would put retail investor’s money into highly-illiquid assets, according to Khalaf.
The scheme was launched by Rishi Sunak during his role as chancellor with the aim of flowing pension fund money into UK infrastructure and start-ups.
Khalif said: “It seems pretty clear then that the drive to get us all investing in illiquid assets is motivated by economic policy, rather than as a result of any significant consumer demand, or even because it’s actually a good idea for private investors.
“If it’s going to continue going down this route, the government needs to make absolutely sure it’s not opening retail investors up to extra liquidity risks simply so it can meet its own economic targets.”