Lessons to Learn
It’s been a busy week in the world of investing, following the suspension of Neil Woodford’s flagship £3.7bn Equity Income fund.
A high level of withdrawals, combined with some illiquid assets within the fund, forced Woodford to impose the suspension, which leaves investors in limbo until trading can resume.
In this blog post, the background of this rare fund suspension, and some of the lessons we can learn from the experience.
Neil Woodford is one of a handful of so-called ‘star fund managers’, heralded for his decades of superior investment performance.
Investment fund managers rarely pick up this ‘star’ title, but when they do, it’s often used as a marketing tool to accelerate the profile and attract new investor monies to their funds.
Woodford’s star first rose when he was an investment manager at Invesco Perpetual.
He moved there in 1988, becoming responsible for their Invesco Perpetual Income and Invesco Perpetual High Income funds, with £10.3bn and £13.6bn of assets under management respectively.
These funds, along with the institutional investment mandates he ran, performed very well relative to similar funds in the sector.
Towards the end of his tenure with Invesco, he managed around £30bn of investor money across the various funds and mandates.
Back in 2012, when the press was fawning over Woodford and his star manager status, one newspaper reported on his performance with a headline that said, “Neil Woodford turned £10,000 into £114,000 in 20 years – can he do it again?”
Resignation and relaunch
In April 2014, Woodford left his role as head of UK equities at Invesco Perpetual, to establish his own fund management group, Woodford Investment Management, and to launch the LF Woodford Equity Income fund.
A year later, in April 2015, he launched the Woodford Patient Capital Trust.
This fund launch set a new record for the largest ever fundraise by an investment trust, with £800 million of subscriptions. It invests in small and unlisted companies, which also became a feature of Woodford’s first fund, albeit with a 10% cap on non-listed stocks.
He subsequently launched another investment fund in April 2017, the LF Woodford Income Focus fund.
According to an interview for What Investment magazine at the end of March:
“Woodford believes that being an active investor means doing something different from the market and adding value through the investment process. It is also active in engagement with company management teams to help understand the long-term aspirations of the company. Its long-term approach to investment management is encapsulated in a patient capital investment style.”
In the same article, he addressed criticism of recent poor performance, reflecting on the challenges of taking a contrarian approach to investing and saying:
“Certainly I have been on the receiving end of a lot of criticism in recent months and it is incredibly uncomfortable. It is not just uncomfortable for me, it has been uncomfortable for the business around me and for everybody who supports me at work. It has been a really challenging time.”
But Woodford stuck to his guns, believing his strategy would continue to be proven right over the longer term.
This week, trading in his largest fund, the Woodford Equity Income Fund, was suspended following large withdrawals by investors.
The run-up to this suspension appears to have started following the EU Referendum in 2016.
At this time, Woodford took the view that British stocks with prospects linked to the UK economy would recover in value, but this play seems to be taking longer than expected. Instead of the value stocks bouncing back, it’s growth stocks driving market returns since the UK voted to leave the EU.
This call to back British value stocks has resulted in a 27.6% fall in the value of the Woodford Equity Income fund since its peak in June 2017.
There have also been specific stock-related issues within the fund, prompting some of his principal backers, like Jupiter Asset Management, to pull out.
Woodford was forced to sell his holding in pension provider and investment broker AJ Bell, as a result of a growing weighting in the rest of the fund to unlisted stocks, which turned out to be lousy timing; AJ Bell announced its plans to float on the stock market shortly afterwards.
With more investors disappointed with the performance of the fund and withdrawing their investments, Woodford took the unusual move earlier this year of transferring some unlisted stocks from the investment fund to the investment trust, in return for listed shares held in the latter.
Another unusual move followed; Woodford listed some of his shares in unlisted companies on the Guernsey stock exchange.
His fund, once valued at £10.2bn, had fallen in size to £3.7bn.
He was then forced at the start of this week to suspend trading in the fund, to give himself time to sell illiquid holdings and make cash available to pay those investors who want to leave.
Woodford stated the suspension, saying he was ‘extremely sorry’ after suspending the trading, and explaining the move was ‘necessary to protect investors’ interests’.
One prominent investor who wanted to get their money out of the fund was the Kent County Council pension fund, who have a £263 million holding in the fund.
After deciding to pull the investment, they discovered trading had been suspended, and they were tied up in the fund for the foreseeable future.
Lessons to learn
There are a few issues to unpick here.
Firstly, from a regulatory perspective, the Financial Conduct Authority appears to be keeping a close eye on the situation, issuing a statement this week to say:
“The FCA’s rules provide for suspension in dealing in the units of open-ended funds where, due to exceptional circumstances, it is necessary to protect all the investors in a fund and Suspensions are recognised as a legitimate tool internationally via IOSCO guidelines.
“We expect all firms involved to uphold their obligations to act in the best interests of all investors and to ensure the fund’s assets are sold in an orderly manner. A suspension should last no longer than necessary to allow the fund to build up sufficient liquidity to meet redemptions again.”
The FCA also commented on the decision to list some of the unlisted shares on the Guernsey stock exchange, explaining it “has been deemed an ‘eligible market’ by Link Fund Solutions.”
According to their statement:
“The FCA was not informed, and would not have expected notice, of any decision to list the fund’s assets prior to their listing.”
The second lesson from this fund suspension concerns the popularity of Woodford as a star fund manager, and his ability to attract massive sums of money to his investment funds quickly.
Looking back at press commentary around the time of both fund launches, the media had a significant role to play in hyping up Woodford. The BBC even referred to him as “Britain’s very own Warren Buffett.”
In a June 2015 profile piece, the BBC ran the headline, “Neil Woodford: The man who can’t stop making money.”
Woodford Investment Management was also heavily backed by a large investment broker, who reportedly generated a third of the assets channelled into the investment manager’s funds.
This investment broker has subsequently removed Woodford Equity Income from its ‘best buy list’, and has agreed to stop charging investors in the suspended fund for their platform fees, encouraging Woodford to do the same in respect of his investment management charges.
It’s hoped that a period of trading suspension will allow Woodford to get out of his unquoted holdings, creating the liquidity needed to meet redemption requests when trading resumes.
Trading suspensions like this are not entirely unheard of when it comes to open-ended investment funds. The issue arises when the open-ended fund structure is combined with hard to sell assets, such as unquoted shares and commercial property.
Following the Brexit referendum in 2016, we saw trading suspended in several UK property funds. This suspension happens when fund managers need to balance the demand for investor withdrawals with the availability of cash within the fund.
It’s what has to happen when you combine relatively illiquid holdings (it’s quite hard to sell a large commercial property) with the ability to buy and sell units in the open-ended investment fund daily.
Illiquid holdings, like commercial property and unlisted stocks, are probably better suited to closed-ended investment companies, investment trusts, where underlying assets can remain invested, and the share price fluctuates based on investor demand, generating a premium or a discount to the net asset value.
For investors in Woodford Equity Income, it’s natural to feel a little concerned following the suspension.
Investors in the fund who were unaware of the possibility of such suspended trading, especially those who bought into the fund directly through an investment broker, and without the benefit of financial advice, will have learnt a valuable lesson from their experience.
The trading suspension might also cause some investors to question the wisdom of following star fund managers. Instead, when selecting suitable investment funds, it makes sense to choose funds that do what they say on the tin, in conjunction with consistent risk-adjusted returns, and low costs.
It’s always a good rule of investing to look out for hype and actively avoid it.
When the press, investment brokers, and others are hyping up a fund, it’s no bad thing to be a contrarian and do something else altogether.