Recently, I received an inquiry email from one of my readers which reads thus: “What are the best and trusted foreign currency denominated mutual funds that offer good returns with low minimum withholding period, i.e. 6months or less…?”
There are two answers to the question: one is on the “best and trusted Euro dollar fund” and another on “low minimum withholding period”. I have decided to talk about the second part of that question first, because I believe that investors are concerned about the “withholding period” of their funds.
An overview of withholding period of a fund
In my understanding, withholding period refers to the minimum period you invest before being able to redeem or withdraw your money. That period and other redemption restrictions or gates determine the liquidity of mutual funds.
What is Mutual Fund Liquidity
Mutual fund liquidity relates to the ease with which investors can buy or sell their mutual fund investments. Selling of mutual fund investment implies redeeming from a mutual fund. Now, that is the concept that will be used in this article.
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Why investors are concerned about liquidity
Liquidity is usually at the forefront of an investor’s mind when considering a mutual fund investment. This is because he or she needs to know how easy it will be to redeem and what time it would take for such redemption to take place including; whether a redemption notice period is required and/or whether a redemption penalty will be made.
How fund liquidity is determined
Fund liquidity is usually determined by the fund managers through the imposition of restrictions on redemptions by way of minimum period before redemption, redemption notice period, and redemption amount. In most cases, one can get a sneak pick of a fund’s liquidity by prying into and through the prospectus.
Analysts at Quantitative Financial Analytics recently combed through almost all the prospectuses of mutual funds in Nigeria to find out how liquid Nigerian mutual funds are. Below are a few of the findings:
Minimum Redemption Period
Our research shows that all the mutual funds in Nigeria, except the Exchange Traded Funds (ETFs), require that investors remain in the fund for at least 90 days before making any withdrawals. The implication of this is that most mutual funds become liquid in the first 90 days following subscription to the fund.
It was also discovered that redemptions that occur earlier than the stipulated minimum redemption period of 90 days or so, will attract penalties ranging from 0.5% to 2% of the amount being redeemed, or the amount of interest/dividend accrued on the investment, in the case of money market funds.
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This means that if you bought into a mutual fund on say, March 1st at N50,000, and by May 1st, the fund had increased to N60,000 and you decide to redeem all your investment, since you have just stayed in the fund for 2 months, you will be required to pay 2% of N60,000 as redemption penalty. As a result, you end up receiving N58,800. The imposition of redemption penalty reduces the liquidity of funds in the early stages of initial investment.
One positive discovery is that the research further shows almost all the mutual funds required no redemption notice period, other than the fact that the redemption request should reach the fund manager no later than 5:00 pm (4;00 pm in some cases) on any business day to be considered or effected on that business day; otherwise, such request would be treated as though received on the next business day. In addition, 99% of the mutual funds, process investor redemption requests within 5 business days following the receipt of such request.
Minimum Permissible Holding
Another means by which fund managers determine or control the liquidity of mutual funds in Nigeria is their requirement for minimum permissible holding. The minimum permissible holding is the number of units of a fund or the amount of investment in a fund, below which an investor cannot be allowed to remain in the fund but presumed to have opted to or “forced” to redeem all the shares or investments in the fund.
This minimum permissible holding differs from fund to fund but ranges from as low as N10,000 to as high as N100,000. The Zenith Equity Fund, for example, requires that an investor has a minimum running balance of N100,000 to remain in the fund while it is N10,000 for ARM Aggressive fund.
Why impose liquidation or Redemption Penalty
The imposition of a redemption penalty acts as a disincentive aimed at dissuading investors from redeeming their shares of a fund, especially when the fund is in distress. It also gives fund manager adequate time to put the invested funds to work.
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Yet another way a fund manager may determine the liquidity of mutual funds is through what is known as redemption gates. A redemption gate is a temporary suspension of a shareholder’s right to redeem shares of a fund. Under normal circumstances, redemption requests received while a fund is gated are rejected rather than held until the gate is lifted. Our research indicated that there is no provision for gates in any of the mutual fund prospectuses in Nigeria however, most of the funds stated that the fund manager may change the minimum permissible holding, which by implication, can be interpreted as the fund manager having the ability to gate a fund.
Why Gate a fund
The major reason why fund managers may place a gate on redemption from a fund is to stem a run on the fund especially when such a fund is under some distress. Another reason is to ensure that the fund manager does not get pressured into liquidating a fund’s asset holdings at sub optimal market values which may be detrimental to the fund. Indeed, redemption gates are the means by which a fund manager who is experiencing difficulty due to extreme market circumstance can control redemptions so as to ensure that all investors are treated fairly and that no ‘first-mover’ advantage is accorded to some investors.
It is important to pay attention to the liquidity of the fund you want to invest in, especially if you intend to pull out of the fund within the short to medium term. This also goes to a situation where you may want to make partial withdrawals from your fund. In that case, you need to know what the permissible minimum holding requirement is so that you are not forced to redeem all your investment because you fail to maintain the required minimum holding.