Recently a major fund house announced that it has shuttered six of their fixed-income funds for want of ‘secondary market liquidity’ and their inability to meet redemption requests.
This meant there would be no further subscription and redemptions in the fund.
The fund would attempt to sell portfolio securities (or realize value any other way) to clear fund liabilities and return balance monies to investors.
The operative word here was ‘liabilities’ which most of us will have missed.
So, our protagonist, the harassed middle management executive, who has now been locked up for over a month asks, how does an investment vehicle like a mutual fund have liabilities?
The answer to that is how does anyone have liabilities? They borrowed money.
And she asks, why?
Well, the fund needed to pay out redemption proceeds and they couldn’t sell securities, so they borrowed money from banks to pay outgoing investors.
So, she asks, what happens if they still can’t sell securities? That’s where the collateral given to the banks comes in – the banks will sell those securities to recover any outstanding.
And what if the fund can sell portfolio securities? Then the bank gets paid first (interest and principal) and then she gets whatever is left.
Thinking for a moment between that zoom call and doing the dishes, she comes to a swift conclusion, it doesn’t sound so bad what’s the real worry? After these are all investment-grade securities?
Here we introduce another entity to the dramatis personae - rating agencies who have provided ratings for funds as well as portfolio securities (mostly investment-grade translating to BBB or higher).
Traditionally, investment-grade security should not have liquidity issues, or it will not be an investment grade.
However, in this case, the security is illiquid and still rated investment grade, and therein lies the rub – the NAV is not realizable and pausing household chores as well as that zoom call, she needs to assess the markets as well as her investments.
Asset allocation
While the fund shuttering is done and a haircut on portfolio liquidation is fait accompli, the underlying problems are not unique to the fund and could have portfolio-wide implications if there are other similar investments in her portfolio.
The first action in such a scenario, therefore, is to do a quick portfolio review to understand where monies are lying.
A word of caution regarding hybrid (debt + equity) funds - it would also be wise to see the current allocation and add these to arrive at overall portfolio-wide asset allocation.
This determines what your level of risk is broadly and, whether she needs to take any action i.e. reallocate if risk higher or lower than desired.
Now between those infamous zoom calls and other chores, it may not be possible for her to quickly review the portfolio and glean actionable intelligence.
It would be simpler to upload the portfolio (extracted from a registrar’s portal) to several trusted portfolio analytics engines available on the web. Once uploaded, she can extract her asset allocation and realign the portfolio to the desired risk and expected return level.
However, if there is no predetermined asset allocation available then an exercise may need to be conducted through a DIY approach, taking help from a paid investment advisor or go in for a platform with heuristic driven, auto rebalancing allocated portfolio.