September 2016 – Liquidity, liquidity, liquidity

Newsletter

There is not much to report at GPS at the moment. We are sticking to our knitting with more of the same type of lending. There is plenty of good quality and smaller loans in the loan pipeline. The current loan book continues to perform.

Accordingly, this month I can get back to a more educational article.

Liquidity is a largely misunderstood concept, but one that runs at the core of many investments. There can be way too much jargon involved, which causes people’s eyes to roll to the back of their heads, as they drift off to a more pleasant place.

In my view too many people look at the withdrawal rights to assess liquidity. They do not look further into how the withdrawal rights will be met. GFC demonstrated that a major cause of failure of investment funds was a misalignment of investment and asset maturity terms. In mortgage funds, we saw some funds offer short withdrawal periods of days or months, but their average loan terms were for many years.

Accordingly, these funds were not able to liquidate assets upon a run of calls for withdrawals.

This caused these funds to become frozen. They are regularly making the news as their affairs are still not yet finalised.

A common liquidity tool, which is still being used, is to claim that assets (loans) can be sold. GFC should have taught us that in a financial crisis this market evaporates. Maturity profiles are a better gauge of the liquidity of a fund, as they deal with a stop lending / run out assets scenario.

In the below graph I have compared GPS to another well-known mortgage fund. It is based on information published on the website of that well known fund and the GPS loan maturity profile as at 31 July 2016.

While liquidity is not the be all and end all, it was an important factor which I considered in designing the GPS product. I wanted to ensure that the GPS loan book could be run out in a timely manner, should there be a total failure of investor confidence in GPS. Neither investors, nor I, would want a procrastinated process. This is why GPS can run out all loans over a maximum of 18 months, (currently within 7 to 12 months as you can see in the graph) while the other well-known fund would only be at approximately 50% with a flattening line looking set for a long and costly process.

Please give me a call if you have any queries.

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