28/06/2019 Feature Articles Back to all News & Views
If the average person in the street could name even a single fund manager in the UK fund management industry, that person would probably be Neil Woodford. Woodford built a stellar reputation running UK equity income funds at Invesco Perpetual (IP), outperforming the UK market by an average of 5% per annum from 1990 to 2014 (source: Morningstar). Such returns made him a hugely popular manager with financial advisers and their clients, as well as with individuals buying their own funds direct. However, his profile has been raised even further in the last few weeks for less positive reasons.

For background, Woodford left IP in 2014 and formed Woodford Investment Management (Woodford IM), launching the LF Woodford Equity Income Fund (this fund was followed by two smaller funds). As one might expect for someone with his reputation, money poured in and the fund hit £10bn in less than three years. In addition, Woodford was appointed to manage mandates for several financial institutions. Performance was initially very strong but fell away quite dramatically, leading to significant redemptions and the fund fell below £4bn before being suspended on 3 June.

A simple web search provides plentiful coverage of what caused the problems at Woodford IM, and we do not intend to repeat the details here. Woodford has come in for a large amount of criticism, some of which is certainly justified. In addition, events have raised a number of issues for the industry to consider, from the role of direct marketing in fund sales to the effectiveness of the current regulations on unlisted or illiquid stocks, and these will need to be debated in the months to come if lessons are to be learned. As various parties seek to protect their reputations in the immediate aftermath, a furious bout of finger pointing has broken out, and how this ‘blame game’ resolves itself will not be known for some significant time. However, we believe investors can take away one (not especially new) lesson more immediately.

Much of the criticism being levelled at Woodford is that he held too much of the fund in illiquid and unlisted start-ups that are difficult to trade. Whilst he did indeed hold an unusually high amount in such stocks, and his usage of Guernsey listings for several stocks to keep within the regulatory limits was questionable, this fact was not hidden. Indeed, in order to promote transparency within the fund management industry, Woodford IM took the unusual step at launch of deciding to list all holdings within their funds rather than just the 10 largest holdings, as is common practice. As a result, anyone looking at the fund should have been aware of the level of illiquid stocks and known that it was not your typical UK Equity Income fund, and Woodford IM never claimed that it was. Furthermore, had they decided that exposure to such small companies was not for them, they could have sold the fund. However, huge numbers of people invested in the fund, with Hargreaves Landsdown (HL), the UK’s largest execution only broker, confirming yesterday that nearly 300,000 of their clients did so. If the fund was so unusual, was it suitable for all of these investors and, if not, how did so many end up invested in it?

It is a truism that the initial and ongoing due diligence required when investing in funds is beyond the expertise and time of most individual investors. Therefore, investors tend to look for alternative ways to decide which funds to buy. One common approach is to invest with a high profile fund manager with a good track record, following them from company to company whenever they move. This effect has become known as the ‘cult of the star fund manager’, as it is often based on reputation alone. However, assessing the likelihood of the manager maintaining their previous performance requires a detailed analysis of how they generated the returns previously, something beyond most investors as they would struggle to access the data required, let alone know how to examine it. In addition, we have seen many examples of fund managers moving companies and being unable to replicate their previous performance, as they can often undervalue their previous place of work, from not appreciating how good the analysts were there to simply how well suited the working environment was to their personality. In Woodford’s case, it may be that the Compliance controls at IP, which he may have felt were over-restrictive and a reason for wanting to set up his own firm, prevented him from getting into his current position. Whatever the truth, a change of company for a fund manager represents a risk point that requires careful consideration, and following them ‘blindly’ is unwise.

A second approach is to ‘piggy back’ other people’s due diligence. In this case, both HL and St James’s Place, the largest financial advice company in the UK, backed Woodford, the former with multiple marketing campaigns and their own multi-asset funds and the latter with a large segmented mandate. However, there is a problem here in the form of a feedback loop. If Woodford is launching a new fund that is likely to be popular with investors, and your business seeks to grow funds under management, the danger is that institutions’ due diligence is clouded by commercial drivers. Therefore, individual investors should be careful about how much weight they place on such corporate decisions.

All of the above reinforces the value of taking advice from an individual or organisation that is not only suitably qualified but is genuinely independent of such potential conflicts, acting solely in the interests of their clients. Of course, plenty of advisers will have invested in Woodford, so taking advice does not guarantee that you will avoid such fund suspensions, and all investment decisions come with some risks (we chose not to invest in Woodford’s fund but that does not mean that we will get every such decision correct). However, they should have known what they were recommending and blended it with other more liquid funds within a portfolio that could withstand such an event without inconveniencing their clients unduly.