We hope you find this archived article informative. Please note that investment, pension, and tax regulations can change frequently, so some content may be outdated. Nevertheless, we aim to provide valuable insights.
If you’ve heard the term “gating,” it refers to the temporary suspension of withdrawals from an investment fund—think of it as putting up a gate to prevent money from leaving. In this article, we explore why fund managers and their corporate directors might resort to this action and consider whether it could occur within the exchange-traded funds (ETFs) that Nutmeg invests in.
Understanding Gating
Gating has gained attention recently due to the Woodford Equity Income Fund’s high-profile case. However, Woodford isn’t the only fund to experience gating; M&G Investments also halted withdrawals from its UK Property Income Fund in mid-July. The key difference between the two is that M&G’s fund primarily served institutional investors, while Woodford’s was aimed at individual or retail clients.
Both are open-ended funds, meaning they can expand or shrink as investors enter or exit. When an open-ended fund invests in illiquid assets—such as properties or unlisted stocks—it may become susceptible to gating. This vulnerability arises because such funds typically maintain a limited cash reserve. If too many investors request withdrawals simultaneously, the fund manager may need to sell underlying assets to generate sufficient cash. In extreme cases, they might find it challenging to sell these assets quickly enough, leading to a gating decision.
Mark Carney, the former Governor of the Bank of England, highlighted the risks of funds investing in illiquid assets while promising daily liquidity, referring to this situation as “built on a lie,” suggesting that the expectation of immediate access to funds can be misleading.
The Role of Fund Directors
Investors often feel frustrated when their funds are gated, but it’s typically done with their best interests in mind. The decision to gate a fund is generally made by its corporate directors to preserve the fund’s overall value for all investors. In the case of the Woodford Equity Income Fund, if withdrawals had continued, the fund manager might have been forced to sell underlying assets at steep discounts in what’s known as a “fire sale,” resulting in broader losses for all investors.
Corporate directors are responsible for ensuring sound governance of the funds. They oversee operations to ensure actions taken benefit all investors. However, they are sometimes criticized for acting too slowly, prompting questions about whether they could have prevented gating in the first place.
How Common is Gating?
While gating is not a frequent occurrence, it tends to arise during periods of significant market disruption. The global financial crisis of 2007-2008 saw many funds suspend redemptions as plummeting stock markets left them unable to sell their holdings at fair prices. In the aftermath, some hedge funds faced lawsuits from investors seeking to reclaim their investments from illiquid assets.
Another incidence of gating occurred in the UK following the Brexit referendum in 2016. The unexpected outcome led to a loss of confidence in the British housing market, compelling several property funds to close for withdrawals.
Other notable examples outside periods of market stress include the gating of the Third Avenue Focused Credit Fund in 2015 and the suspension of some absolute return bond funds by Swiss asset manager GAM in 2018.
Could Nutmeg’s Investments Be Gated?
Nutmeg invests primarily in exchange-traded funds (ETFs), which offer transparency by allowing constant visibility of all underlying holdings. Additionally, ETFs are traded on exchanges, meaning they can be bought and sold similarly to stocks, providing a high level of liquidity.
Could an ETF be gated? In theory, yes. ETFs share structural similarities with other mutual funds and could potentially be gated if their corporate directors decide to take that route. However, several factors suggest that this situation is unlikely for ETFs.
One key distinction is that ETFs have access to a secondary market. Traditional mutual funds lack a dedicated marketplace for buying and selling fund holdings. In contrast, ETFs can be traded daily on global stock exchanges, enabling investors to exchange their fund shares for cash without redeeming them directly with the fund provider. This flexibility allows ETF investors to maintain liquidity, even when some mutual funds are gated.
A prime example of the benefits of this secondary market occurred in 2015 when the Greek stock market was closed for five weeks. While Greek equity funds were gated due to the market closure, ETFs remained tradable in the U.S., enabling investors to access liquidity throughout the shutdown.
Why Nutmeg is Different
At Nutmeg, liquidity is central to our investment strategy. We do not invest in illiquid securities, and our in-house investment and trading teams use leading market insights to evaluate the liquidity of our holdings.
While gating is a risk inherent in open-ended funds that invest in illiquid assets, our investment process minimizes the likelihood of experiencing such events, setting us apart in the industry.
Risk Warning
As with all investments, your capital is at risk. The value of your Nutmeg portfolio may fluctuate, and you may receive less than your initial investment.
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