View the article online at http://citywire.co.uk/wealth-manager/article/a737633
Supertanker funds: liquidity issues in shallow waters
by Jonathan Beckett on Mar 07, 2014 at 11:31
Supertankers tended to ‘yaw’ rather than steer like conventional ships. This is when the entire body of the ship moves sidewards, with the rear often adopting an attitude angle greater than the front of the ship as it tries to turn. In investment terms, this would be similar to when a huge fund tries to dump a large amount of its assets into the market through program trades.
As the fund exerts a large impact on the trading volume (and hence price), then the order book moves around the fund as much as the fund is able to get in and out of the market.
Quite often there are insufficient participants to trade the other side of the book with the fund manager. The manager is then forced to trade out/in progressively and thus has to accept the shifting price (‘yaw’) on day three in response to his trading on day one.
Many harbours in the 1970s could not accommodate these leviathans and if you look at the size of some funds and the markets they operate in, the lure to compare the depth of liquidity and water is tempting.
The effects of shallow water
We have seen banks reducing their proprietary trading to meet new regulation and capital controls. This suddenly removed some of the largest market-makers and anecdotally, is causing liquidity tightening in various markets, such as in bonds (according to fund managers) but the evidence isn’t cohesive yet.
I believe we are in a similar position with mutual funds today. When does navigating market liquidity become too onerous with growing capacity; when is big too big?
Moving in shallow water causes handling issues. Ships have greater inertia in shallower water, so are less responsive to changes in speed and course. As speed is reduced, so too is steering control, meaning the pilot has to be prepared to make prudent compromises.
It is therefore logical that supertanker funds can navigate larger, more liquid markets more easily than smaller, less liquid ones. This point has been put into focus by the unlisted microcap positions in Woodford’s Income and High Income funds, which his replacement, Mark Barnett, will have to endeavour to trade out of at some point.
On larger funds, where the trading ability of the manager is slow compared to the volume of assets required to be traded, this can have a significant bearing on tactical asset allocation decisions.
By owning so much of the market, a supertanker fund may become susceptible to unexpected ‘beta’ shocks as the trading volume around its positions becomes shallow and therefore even small volumes of trade can have a disproportionate impact on the price of its holdings.
News sponsored by:
As the UK coalition government strives to rebalance the national economy, so called 'reshoring' looks set to play an increasingly important role in economic recovery.
Today's top headlines
With talk on interest rates on the horizon, our latest roundtable debate covers income investing against a changing backdrop
More about this:
Look up the funds
- Standard Life Inv Glo Abs Ret Strategies Ret Acc
- Invesco Perpetual High Yield Acc
- Invesco Perpetual High Income Inc
- Invesco Perpetual Income Inc