"The risk team regularly compares the liquidity of underlying assets to a fund’s redemption profile under normal market activity and under several adverse scenarios, including fund manager departures, large single redemptions and stressed market conditions."
Liontrust says that examining the liquidity across a range of different plausible scenarios is of more value than a headline analysis using ADV.
"Liontrust’s experienced centralised trading team also plays a critical role. Strong relationships with the sell side are key to discovering the other side of a trade for small caps.
"It is important to recognise the inherent limitations of ADV-based liquidity models for smaller companies.
"Liontrust regularly trades in volumes which represent many multiples of average daily volume in our small cap equities.”
The spokesperson also highlighted the following:
- The Liontrust Special Situations Fund does not invest in any unquoted stocks.
- All of the companies in the portfolio are listed on the London Stock Exchange or Alternative Investment Market.
- The fund is committed to holding between 20-30 per cent of net asset value in smaller companies and AIM (31/10/23: 23 per cent).
- Some 73.2 per cent of the fund’s assets are invested in FTSE350 stocks; within that, 45.7 per cent of fund assets are currently invested in highly liquid FTSE100 companies.
- Cash levels are typically between 3-7 per cent.
But Saporta saysin his note:“If one assumed that the portfolio managers would want to account for 20-30 per cent of the average daily volume, some positions would take years to exit without destroying the share prices of their own holdings.
"The [then 6.4 per cent] cash allocation is certainly not a big enough cushion. It is no mystery that UK small and mid-cap stocks have been in a funk for some time with liquidity completely drying up.
"If redemptions continue at the same rate, or even accelerate in the case of a market crash, the portfolio managers will find it impossible to sell the illiquid positions in the same pro-rata of the redemptions than the larger market cap stocks held by the fund so that the proportion of illiquid securities will automatically increase.
"Moreover, in such cases, speculators and investors will want to front-run the fund, shorting those illiquid securities and prompting further losses at the funds.”
Those comments were made prior to the most recent outflows, of more than £100mn a month in both September and October.
Sum of its parts?
"Front running”, as Saporta references above, occurs when investors, aware of the redemptions from a fund potentially forcing the sale of small caps, may decide to short sell the stock in question as they are aware a big seller is in the market and so the price will fall.
Or, as one of the professional investors mentioned above commented to FTAdviser, without knowing the name of the fund in this article: "If I see large blocks of stock coming onto my screen as being for sale, I will know it's coming from a forced seller, and I will try to push the price down – everyone in the market would."
Liontrust states that the potential for front running to adversely impact the prices they can sell stocks at is one of the factors considered by its dedicated liquidity risk team when measuring the liquidity of the fund.
