Ignore the sceptics

The issue of liquidity in open-ended funds has hit the headlines in recent weeks, with much of the spotlight focusing on small and micro-cap stocks.

Our investment process has been designed over many years to mitigate the inherent risks of smaller company investing and has been borne

out by longer-term risk-adjusted return measures.

By focusing on smaller companies, we offer investors a differentiated proposition relative to the majority of competitor strategies, which means our funds exhibit low correlation to even the closest peers.

⏸ Be capacity awareThe key starting point to delivering attractive long-term returns is having a clear understanding of the capacity of an investment strategy. We strictly adhere to this and do not raise more money for a vehicle than we believe we can effectively manage. We have clearly communicated the capacity constraints of our

small and micro-cap strategies to investors.

� Cultivate relationships We have been investors in less liquid listed companies for well over a decade. We undertake our own dealing, which requires maintaining direct relationships with sales traders at every broker of small and mid-caps. This can be key when trying to achieve liquidity at the smaller end of the market.

Ken Wotton, Gresham House Equity Funds

How to manage liquidity effectively when investing in small caps

While stocks at the smaller end of the equity market often exhibit lower levels of liquidity than larger peers, it must be remembered small and micro-cap stocks are less liquid - not illiquid.

Nevertheless, managing liquidity in funds focused on small and micro caps is crucial for delivering long-term performance and meeting investor needs. Liquidity matters at a stock level, for building and exiting positions, as well as delivering target returns.

More importantly, liquidity in open-ended funds allows investors to deal on a daily basis. In closed-ended vehicles, day-to-day liquidity risk is passed down to the end investor, who can buy and sell shares in the strategy. However, they must consider market liquidity in those shares and bear the cost of any discount or premium to NAV.

In open-ended funds, the manager takes responsibility for this risk. As longstanding smaller company investors, we are aware of the intricacies of less-liquid stocks.

Liquidity is a core component of our investment process when selecting stocks, determining target returns and formulating portfolio weightings. We also actively monitor liquidity at an aggregate portfolio and fund level, and it forms a key measure for risk monitoring and oversight.

Gresham House Asset Management

Octagon Point, 5 Cheapside, London EC2V 6AA

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© 2019 Gresham House Asset Management Ltd.

📈 Stock selectionModelling returns for individual stocks must consider assumptions of entry and exit prices, factoring in appropriate liquidity adjustments where relevant.

As investors, we must form a judgement as to the likely liquidity for both entry and exit, taking into account historical trading volumes and size of free float. We also need to assess the shareholder register and build a detailed understanding of the market through discussions with trading desks at the relevant brokers.

↕ Position sizingStock-level liquidity forms a crucial component of our proprietary conviction scoring methodology, which determines the size of an individual investment within an overall portfolio.

💷 Liquidity buffersTo mitigate redemption risk, we take a multi-faceted approach to managing liquidity at the portfolio level. We target a minimum cash level of 5% of NAV and typically operate within the range of 5-10%.

Our funds also have access to a short-term borrowing facility of up to 10% of NAV, allowing material redemptions beyond the available cash to be met in accordance with daily dealing.

Moreover, portfolio construction explicitly takes into account liquidity, seeking at all times to balance less liquid holdings with more liquid holdings.

Finally, internal and cornerstone investors form a core part of each of our open-ended funds, providing a layer of sticky patient capital and ensuring available liquid assets are maintained at a prudent level.

About the author

This article is distributed by Gresham House Asset Management Limited (Gresham House) which is authorised and regulated by the Financial Conduct Authority with reference number 682776. The views and opinions expressed in this article are those of the author only and do not necessarily reflect the opinion, policy or position of Gresham House. Highlighted financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or investment advice. Past performance is not necessarily a guide to future performance.

Ken WottonManaging Director, Quoted Investments

Ken joined Gresham House in November 2018, having previously spent 11 years with Livingbridge leading the Equity Funds investment team, managing listed investments.

After graduating Oxford and qualifying as a Chartered Accountant with KPMG, Ken moved into equity research with Commerzbank and Evolution Securities, where he built sector expertise in telecoms and technology and knowledge of listed companies and corporate transactions.