The top funds are starting to resemble a series of exclusive nightclubs - only available to a select few investors, who are already well-known to management. This week saw HSBC take steps to slow flows into its popular frontiers fund, while St. James's Place stepped in to control the size of its Asian and UK strategies.
The trend started with the major emerging market franchises at Aberdeen and First State, who both took steps to slow investment into their funds after fund flows threatened to create liquidity problems. It has gathered momentum since: Schroders has soft-closed a number of its small-cap and Asian-focused funds, Standard Life and Fidelity have also soft-closed funds.
It represents a profound change of sentiment for an industry previously focused more exclusively on asset gathering. In many ways, it is a welcome change. It is reasonable to assume that fund managers perform better when bulging assets do not constrain their flexibility. It suggests that fund managers are more concerned with preserving the interests of existing shareholders rather than rapacious asset gathering, a laudable objective.
However, question marks remain over whether it is an effective tool to stem flows into a fund. There are concerns that a fund will attract greater inflows as investors rush to invest in fear that they won't be able to do so in future. Although it has worked to stem flows in some instances, it has often coincided with a reversal of fortunes for an individual asset class – such as emerging markets or corporate bonds.
Oliver Wallin, Investment Director on the Octopus Multi Manager team, says: "In principle, the desire for investment companies not to compromise their investment strategy is a good thing, and for particular markets, necessary. However, it is becoming problematic to implement. Findlay Park soft-closed fifteen years ago and this has been very effective. However, now the popularity of platforms creates problems for fund groups."
Wallin points out that the strategy of closing a fund to new investment does not always act to stem flows because a platform can be deemed to be the end investor. Therefore all investors on the platform can still access the fund and the fund still attracts assets. As a result, soft closure may be becoming a less effective method of controlling flows.
Robin Stoakley, head of UK intermediary at Schroders, says that the process of soft-closing a fund has some elements of art and science. In taking the decision to soft-close, the group will look at the target stocks, the size of positions and the average daily trading volume, to come up with an approximate length of time to exit a position. It will also look at turnover – a higher turnover fund needs more liquidity than a low turnover fund – and at whether the fund is focused on less liquid areas such as small- or mid-cap stocks.
It is Schroders' strategy to keep funds on platforms. As a result, the process of soft closure will start significantly ahead of an actual capacity limit. For example, a fund with a capacity of £3 billion would be likely to come under review at £2 billion, and the process of closure start at £2.5 billion.
He says that the fund surges tend only to happen when investors are given notice of a hard closure. In most cases, he adds, the radar simply shifts to alternative funds: "Most funds that are soft-closing are mature and therefore have a natural redemption level of perhaps 5-10% per year. The ideal in this type of fund is to get to a situation where the inflows and the outflows match."
The issue of soft-closure is likely to become more important at a time when the industry is seeing greater concentration in a smaller number of funds. If managers cannot effectively soft-close funds, there is a risk that funds will become too large and deliver poor returns to investors. Investors need to be reassured that fund managers are on top of the process.
