Soft-closing a fund is not a clear cut option and there are many ways in which a fund manager can tackle liquidity and capacity issues, according to Polar Capital’s Iain Evans.
When a fund becomes popular and investors pour money into it, this can create capacity issues for the manager and limit what they can invest in.
This is especially relevant in small-cap and more specialist sectors, as a fund could simply become too big to invest in young businesses.
In this situation, a fund can soft-close, whereby new investment is met with a less attractive front-end charge. Less often used is a hard-closure, where no money can enter the fund.
With that in mind, Trustnet spoke to Iain Evans, global head of distribution at Polar Capital, to understand the reasoning behind a soft-close and what other methods could be used.
Capacity can be a difficult balance for an active fund, as the amount of assets under management (AUM) can limit other alpha-generating investments and close off opportunities that were once available.
“The most important thing from an investor’s perspective is you want to know your manager is cognisant of the impacts of capacity and is willing to soft-close or close a fund to protect future performance,” said Evans.
“There will always be tension between maximising revenue and what will then negatively impact future performance.”
On small-caps, for instance, he outlined that the big driver of capacity is market liquidity.
This was the case for the $1.4bn Polar Capital Biotechnology fund, run by David Pinniger.
“If we got much larger, then David would be precluded from buying some of the stocks his process would drive him to buy,” Evans added.
Indeed, Pinniger, who soft-closed the fund in 2018, has previously described a ‘Goldilocks zone’ for an active biotech fund at around 40-50 holdings. This, he said, avoids too much risk or too little reward.
Evans explained that another aspect of capacity management which isn’t as well-documented is how much time and capacity the managers have to effectively manage their client base.
Indeed, it’s likely that successful and well-known managers may be running more than one fund.
“They may also be running segregated managed accounts for institutional investors,” he added. “Then it becomes a question of ‘my underlying liquidity is fine – but I can’t manage anymore clients’.”
That prompted the soft-closure of Polar Capital’s Global Technology fund, which closed itself to new investors in June of last year after £1.6bn of inflows over three months increased its AUM to £4.5bn.
Fund size of Polar Capital Global Technology
Source: FE Analytics
This was an increase of 256.4 per cent over three years.
“The quantitative capacity figures were below the liquidity capacity, but the team felt they couldn’t continue to service clients in the way they would want to if they let that number go up anymore,” he said.
So how does a manager go about soft-closing a fund?
“A front-end charge is just one way,” said Evans. “Historically, we’ve not used that as we try and talk about capacity constraints right from the outset.”
Therefore, before there’s an issue in capacity Polar Capital will stop marketing.
“I call it a soft-soft-close,” he said. “You don’t even tell the market you’ve soft-closed you just stop marketing and this tends to reduce demand.
“Another solution we’ve used historically is to limit existing investors to a maximum investment per dealing day.”
Evans said that worked well as it was driven by underlying liquidity: “It meant the manager knew the maximum amount of money they would have to invest in the market on any given day.”
Having said that, he said this is a luxury afforded to specialist funds with fewer investors and away from the major platforms.
“If you’re a BlackRock for instance, managing larger funds which are on all the platforms, then that’s really hard to do,” he said.
Of course the final option if none of these work is a hard-close, something Polar Capital last did in 2006.
“Hard-closing makes your clients lives difficult, especially as they would have to take it out of existing portfolios and, for wealth managers who are running models, to not be able to put a new client into that model is a big issue for most investors.”
However, in terms of a soft-close, Evans countered that increasingly investors have become more receptive and appreciative of these measures.
“More often than not, they think it’s a great idea,” he added. “But they want you to soft-close to everybody else except them!”
Interestingly, Evans said that the issue isn’t exclusive to funds and wealth managers can experience this capacity issue.
“If you’re a wealth manager and getting larger, does that ultimately preclude you from the really interesting niche specialist fund managers?” he asked.
“Because if there isn’t sufficient capacity to put that fund across your entire range of portfolios you can’t use it.”