Nick Bruining: What happens when there’s a run on redemptions from an investment fund?

With news that the corporate watchdog had placed an interim stop order on one of Australia’s most popular alternative income funds, many investors are now worried about the safety of their money.

The next few weeks could be significant.

La Trobe Financial’s popular 12-Month Term Account and the 2-Year Account were stopped from accepting new investments for 21 days from September 18, unless the Australian Securities and Investments Commission revoked the stop order earlier.

This order was lifted on affected funds last Wednesday, but another La Trobe product, it’s US Private Credit Fund–Class B, remains suspended.

At this stage, there is no suggestion that any fund assets are stressed or that La Trobe cannot meet its redemption requests.

“The interim stop order does not relate to a view on the performance of our assets, portfolios, or product design,” La Trobe said.

“Since the launch of our retail asset management offerings in 1989, none of our portfolio accounts have experienced any gating of liquidity or freezing of withdrawals.”

ASIC said La Trobe has $20 billion of funds under management with more than 120,000 investors.

According to La Trobe’s August Investor update, more than $11b is invested in the popular 12-Month Term Account, used heavily by retirees chasing higher returns. According to the update, the annual return paid to investors to the end of August was 6.25 per cent.

In its announcement, ASIC said the order was issued to stop investors from putting money into products that may not be suitable for their financial objectives, situations or needs.

“This stop order referral arose from ASIC’s retail private credit surveillance which focused on fund transparency, governance, valuation practices, management of conflicts of interest and fair treatment of investors, conducted as part of its response to Australia’s evolving capital markets,” the watchdog said.

The order prevented La Trobe from dealing or issuing product disclosure statements or providing general financial advice to retail clients intending to use the affected products.

An industry insider, who asked not to be identified, said the next few weeks could be critical for La Trobe.

When any income fund has a small percentage of the fund’s assets held in cash to meet redemptions, the fund typically relies on new and renewed investor deposits to meet normal redemption requests.

If a large number of redemption requests are received at the same time, the liquidity of the underlying assets — the mortgages — may become an issue.

Like any longer-term loan, the fund manager can’t simply call in the loans to meet the redemption requests and repay investors. In effect, it is a kind of mismatch between the term of the loans and the term of the investment.

The issue is if the value of the requests overwhelms the available liquid funds on hand.

In this case, and if no other funds are available, fund managers typically freeze redemptions so that no one investor is preferentially treated compared to other investors attempting to withdraw.

This can often exacerbate the situation with new investors reluctant to invest and existing investors wary of reinvesting any maturing investments.

To raise the cash, the mortgage assets themselves might need to be sold, and if there’s a significant amount of money to raise, this could see a need to sell those assets at a discount. That might mean a reduced payout to investors and delays in the payments being made.

On its website, La Trobe said redemption requests were being met.

“We are continuing to pay redemptions on time and in full and have ample liquidity within the La Trobe Australian Credit Fund and the business more broadly, to continue to meet these obligations,” it said.

Nick Bruining is an independent financial adviser and a member of the Certified Independent Financial Advisers Association