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When Luke De Stefano learned last week that £28,000 of his money was suddenly trapped in Neil Woodford’s Equity Income Fund, he was left not only stunned but seriously inconvenienced.

Having been expecting to sell some of his holding, he was caught short by the shock suspension of fund withdrawals. “When it happened it put quite a lot of pressure on me because I had commitments I couldn’t fulfil. I had to pass up a couple of other opportunities too.”

Like thousands of other individual investors, he was enticed by the glittering reputation of the UK’s best-known stockpicker. Mr De Stefano, a 23-year-old City worker, had put his money in Mr Woodford’s eponymous fund, hoping for the sort of returns the star manager had achieved in his previous job at Invesco.

The difference with his investment in the £3.7bn Woodford Equity Income Fund — made mainly through a financial adviser via the broker Hargreaves Lansdown — was that he had no idea of the fund’s position in hard-to-sell assets. He says he feels let down not only by the fund manager but by Hargreaves. “That’s the thing I wasn’t aware of when I was getting involved — the amount of illiquid assets that had no market, really. It wasn’t explained.”

Mr Woodford launched his equity fund to great fanfare in 2014, building assets that climbed to £10.2bn in less than three years. The freezing of withdrawals last week, triggered after too many investors tried to take their money out, has sent shockwaves through the City and the investment community. It has left private investors like Mr De Stefano wondering when he will get access to his money and how much of it will be there when he does.

But the tale of investment woe also raises wider questions about the workings of the market, including whether open-ended funds should hold assets they cannot immediately sell, the role of fund supermarkets in promoting funds through “best buy” lists and the potential for damage to the active management industry. As investors consider their options, FT Money assesses the fallout from the Woodford affair.

Locked-in syndrome

Having suspended his flagship fund for at least 28 days, Mr Woodford is now trying to sell down its illiquid and early-stage holdings in the hope that he will eventually be able to reopen it. In a letter sent to customers on Tuesday, Mr Woodford promised that when the fund opened its doors again it would be “much more liquid”.

Analysts expect the initial suspension period to be extended. In one scenario, the fund could be reopened within several months — a similar timeframe as the property funds that gated in the wake of the UK’s Brexit vote — and start life again as a slimmed down version of its former self. Under those circumstances, patient investors might eventually experience a rise in performance over the long term.

But the risk associated with reopening the fund is high, since it could trigger another fire sale by investors. And anyone taking money out at that point could lose a large chunk of their initial investment.

At the other extreme, Mr Woodford could opt to liquidate the fund, sell down his investments and return money to investors as soon as possible, spelling the end of the fund entirely.

Ryan Hughes, head of fund selection at broker AJ Bell, says that is a “less likely outcome” than the fund reopening, but much would depend on the market conditions in which Mr Woodford is attempting to sell the illiquid parts of the portfolio.

Whether investors will have lost money when the fund reopens depends on the movements of about 100 underlying holdings. The pressure on Mr Woodford to sell the less liquid elements is likely to depress their prices, Mr Hughes says, but the suspension gives some relief from a forced immediate sale — and other stocks in the fund may perform well during that period, offsetting some of these losses.

“On balance, it’s probably prudent to assume that when the fund reopens, it does so at a lower price than the suspension price but it is impossible to quantify this,” Mr Hughes says.

Mr Woodford has previously turned to investment trust Patient Capital trust as a way of easing liquidity issues in his flagship equity fund, having undertaken a complex and controversial shares-for-assets swap worth £73m in March. But analysts say a repeat of that deal looks unlikely — and it is even less likely if Mr Woodford is removed as the manager of Woodford Patient Capital Trust. On Tuesday, it emerged that the board of the trust was considering ejecting him as manager of the listed investment trust that bears his name.

Those with investments in Mr Woodford’s two investment vehicles that are still trading have not been insulated from the travails of the equity income fund. His other open-ended fund, Woodford Income Focus, began two years ago with £500m of capital from investors but its assets had fallen to £340m on Friday through a combination of poor performance and investor withdrawals. Meanwhile, shares in Woodford Patient Capital Trust, the investment trust, have also suffered from the firestorm around the veteran manager and are now sitting on a discount to net asset value of about 26 per cent.


Open-ended and illiquid

Mr Woodford’s fund suspension has reopened debate over a fundamental flaw with open-ended funds that invest in illiquid assets. These funds offer investors the ability to buy and sell on a daily basis — but their managers cannot do the same with the assets they hold, such as property or early-stage companies.

It is an issue that crashed into the public consciousness with the gating of some £15bn worth of property funds following the Brexit referendum. Such funds, a favourite with UK retail investors, were forced to suspend trading in 2016 after investors rushed to redeem and the value of the portfolios fell.

The UK financial regulator mounted a consultation into funds invested in illiquid assets last October, suggesting funds could be forced to suspend trading if there was any doubt about the value of at least 20 per cent of their portfolios. The Financial Conduct Authority (FCA) is yet to come back with final decisions on property funds, but its chief executive, Andrew Bailey, last week weighed in to say the rules around funds may need to change as a result of the Woodford episode.

Mr Bailey said he was considering an intervention that would bar daily withdrawals from funds holding hard-to-trade assets and force funds to keep to assets in jurisdictions chosen by investors.

“This is already an area that is on their radar given the issues that faced commercial property funds in the aftermath of the EU referendum, so I expect this debacle to intensify that debate,” says Jason Hollands, managing director of broker Bestinvest.

Mr Hollands says he supports the idea of limiting open-ended dealing for funds invested in illiquid assets. “This is where the sensible debate is to be had. If a fund is going to invest in illiquid assets, then there is a case for either adjusting the frequency of dealing once those assets are above a certain threshold or requiring such positions to be partially offset by some other form of very liquid collateral.”

Chris Cummings, chief executive of mutual fund trade body the Investment Association, says any crackdown on open-ended funds investing in illiquid assets could be bad for customers, arguing they benefit by being able to choose from “a great diversity of fund options which are designed to suit their investment goals”.

“This can mean not only investing in the shares of listed companies, but also a wide range of other assets, including bonds, property, infrastructure and the opportunity to invest in companies which have yet to offer their shares to members of the public,” he says.

But Richard Wilson, chief executive of fund platform Interactive Investor, said: “Recent events have demonstrated again, were it needed, that the open-ended structure can be the wrong home for illiquid assets.”

Goodbye to ‘best buy’?

The implosion of the fund has also thrown a harsh spotlight on the role of one of Mr Woodford’s biggest cheerleaders, the fund supermarket Hargreaves Lansdown, in promoting the equity vehicle to investors. Scrutiny has fallen on the Wealth 50 “best buy” list, Hargreaves’s closely watched list of funds, in which Mr Woodford’s stricken fund featured right up until its suspension. Last week the broker pulled both Woodford Equity Income and the still-trading Woodford Income Focus from the favourites list.

Having consistently backed Woodford Equity Income in its favoured list since the fund launched five years ago, Hargreaves is now under pressure from MPs on the influential Treasury select committee to answer questions over its commercial relationship with the fund group — including whether any fees were taken as part of its inclusion. Hargreaves said it would reply in due course.

More broadly, the episode has triggered regulatory scrutiny over the way investment platforms communicate with investors — and investors could find their access to information curtailed as a result of the fallout. The FCA is looking again at whether fund supermarkets are compiling their lists of preferred funds, which are popular with DIY investors, in a truly impartial manner.

Some believe such lists serve a useful purpose, in spite of the problems exposed by the Woodford meltdown. Holly Mackay, founder of consultancy Boring Money, says: “Best buy lists have been understandably criticised. But we know that the single biggest source of concern for consumers, and the biggest demand for help, is around which investments to buy.

“Not everyone can see a financial adviser and for those who can’t, recommended fund shortlists are a critical part of the investment infrastructure. Trying to get rid of them or to position passive [investing] as the only alternative is slightly short-sighted,” she says.

“That said, we need to think about how better to tell people about the nature of these [lists].”

Critics argue that investors are being tempted to invest in poorly performing funds based on their appearance in best buy lists. There is currently no regulation governing the lists and platforms can select their own criteria for inclusion — something that needs to change, they say.

When judging which funds to place in its list, Hargreaves included the fee discounts it negotiated with fund managers, a fact that critics say creates a conflict of interest by prioritising cost over performance. The company argues that customers benefit from the lower charges and says it also considers other metrics in its calculations.

Mr Wilson of Interactive Investor says recent events “should lead to better, more rigorous buy lists”, adding “we have always said that rated lists should be free from commercial bias, with a strict, rigorous, easy-to-access methodology that is instrument agnostic.”

Interactive Investor’s website includes details of the selection process behind its “Super 60” list, which names active as well as passive funds — it includes equity funds, investment trusts and exchange traded funds — and it says the listing, which has not included Woodford funds since its launch in January this year, has “no hidden commercial considerations”.

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Active managers under pressure

In the UK firmament of star fund managers, none shone as brightly as Neil Woodford. His vertiginous descent has brought questions over whether investors are right to put their trust in the ability of an individual manager to outperform the market over the long term — the fundamental question in the debate between active and passive funds.

Beating the index is certainly hard to do. According to rating agency Morningstar in its European Active/Passive barometer, active managers both survived and outperformed their average passive peer in only three out of 49 investment categories in the 10 years to the end of 2018. Active managers’ success rates also declined over the same period.

Not all fund managers are created equal however. UK mid-cap managers have performed better on average, with two-thirds outperforming their average passive peer over the past 10 years. And the best performing active funds over 10 years far exceed the returns of the average passive fund in the UK market.

James Norton, senior investment planner at Vanguard UK, says the great majority of fund returns in active funds are generated simply by being invested in the market (the “market beta”, in the investment jargon). That means investors could be paying over the odds for returns they could enjoy in a cheaper, passive fund.

“The investor pays a very large premium for potential excess return of the manager. Keeping costs low is therefore vital to succeed in active management. Excess return is hard to deliver and an investor needs to ensure that the potential excess return or ‘alpha’ is higher than the costs they are paying.”

The Woodford saga is far from over, but it is nonetheless likely to put more wind in the sails of the passive fund movement. A longer-term danger is that, as it continues to unfold, the Woodford revelations will drive fearful or novice investors away from the stock market, leaving their assets to languish in low-return deposit accounts.

Mr De Stefano is not one of them, but he is clear that the experience has left him a good deal more cautious about investing. “There’s a few other funds I’m involved with which I’m looking into a lot more closely. I’m weighing up what my next move is.”

As Mr Wilson of Interactive Investor says: “If recent events affect investor confidence in the financial services industry more generally, this would be an absolute tragedy.”

Pensions committees in the spotlight

Committees charged with keeping a check on workplace pension schemes are under scrutiny after turmoil at Neil Woodford’s flagship fund froze hundreds of millions of pounds in pension cash.

The Financial Times revealed this week that around 1,700 members of the Hargreaves Lansdown pension scheme were among thousands of investors now prevented from withdrawing money from Woodford’s Equity Income Fund, after trading was suspended.

Questions are now being asked of the role of independent governance committees (IGCs) which oversee contract-based workplace pension schemes, including the investment choices offered to members by scheme managers.

It emerged this week that in a 2019 report, the IGC of the Hargreaves pension scheme had said it was “satisfied” with the “rigorous and robust processes” in place for a list of preferred investments, known as the Wealth 50, which HL promoted to its clients, including pension investors. The list included Woodford’s Equity Income Fund.

The chair of the Hargreaves Lansdown pension scheme IGC said he would consider apologising to retirement savers trapped in Neil Woodford funds after endorsing the Wealth 50. David Grimes said his committee did not spend enough time reviewing the selection process used to choose investments on the list of Hargreaves’s favoured funds.

Baroness Ros Altmann, a former pensions minister, said: “There may be cases where IGCs have taken their eyes off the ball and members’ interests may not be clearly protected on a continuous basis.”

Introduced in 2015, IGCs have a duty to scrutinise the value for money of the provider’s workplace personal pension scheme, taking into account transaction costs, raising concerns and making recommendations to the provider’s board as appropriate. Unlike pension scheme trustees, IGCs do not have a legal duty to act in members’ best interests.

Following the report in the FT, Angela Eagle, a Labour MP, lodged a Parliamentary question asking what the Treasury was doing to ensure investment choices offered to workplace pension savers were not overlooked by IGCs.

Josephine Cumbo

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