The ghost of Neil Woodford continues to haunt the fund management industry.
His eponymous boutique came crashing down in 2019, leaving thousands of investors nursing losses. Most of them are still awaiting redress.
At the heart of Woodford’s problem, aside from a degree of hubris, was his open-ended Equity Income fund’s exposure to illiquid assets. Those companies can offer outsized growth opportunities but come with greater risks.
As markets fell and a clutch of his stock selections tumbled, investors withdrew their cash, prompting Woodford to sell more of his publicly traded stocks to meet the redemptions. This meant his unlisted holdings, which are harder to sell, represented a larger chunk of the fund. It became a vicious cycle that ultimately resulted in the fund’s suspension, trapping investors.
What have active fund managers learnt? While many companies do not have the same scale of exposure as Woodford in open-ended funds, it has not been eradicated as an investment practice.
The likes of Fidelity and Allianz are among the biggest names offering open-ended funds with some holdings in unlisted businesses. Others, such as Schroders, will allow for it if the company is due to be listed imminently.
As large fund groups, these companies have robust risk management processes and liquidity checks in place, with only some of their funds owning a small amount of unlisted stocks. Some groups, however, refused to answer when asked by the FT if they held unlisted companies in open-ended funds, suggesting a lack of transparency.
Authorised corporate directors, the fund “supervisors” who are charged with overseeing a fund’s liquidity profile, are also accountable. Woodford’s ACD, Link Fund Solutions, is currently in discussions with the Financial Conduct Authority about recouping money for investors to avoid a hefty fine.
Liquidity is not the only issue. Investors might feel they are in the dark when it comes to the value of their unlisted holdings. Unlike publicly traded shares, the valuation metrics used for private companies are opaque. There is also a dislocation between public and private markets: global equities fell by a fifth last year, while private equity firms reported modest markdowns by comparison.
Some fund houses have taken action. Earlier this month, Jupiter’s chief executive decided the group’s funds would no longer make new investments in unlisted stocks. The move came just as its UK Mid-cap fund offloaded a 6 per cent stake in private company Starling, a digital bank.
While investment trusts are far better suited for illiquid assets, analysts have warned about the amount of exposure in some cases. Private companies held by Scottish Mortgage, one of the UK’s most popular investment trusts, rose above its 30 per cent threshold at the end of last year.
Property funds are problematic, too. Many of them came unstuck after the 2016 Brexit vote as nervous investors, concerned about valuations, rushed to pull out their investment. As a result, funds were forced to temporarily “gate”, in effect trapping investors in the fund. The same gating problem occurred again in 2020 as the pandemic took hold and last year in the wake of the “mini” Budget.
Some open-ended property fund providers have since closed down their products, citing liquidity management issues. Other countries, such as the US and Japan, tend to opt for closed-ended real estate trust structures.
The Financial Conduct Authority in the UK has proposed rules to safeguard investors in the property sector, suggesting they give a notice period to redeem so funds have time to sell the property investments. It has yet to finalise the changes, though.
Last week, the FCA said it was also considering rules around liquidity management across the asset management industry.
Regulators have long been grappling with the issue. Even Mark Carney, former governor of the Bank of England, said in 2019 that funds investing in illiquid assets that enabled investors to withdraw money at any point were “built on a lie”.
His point was that despite the liquidity mismatch, those funds pretend they are like ATMs. Woodford reminded us that act can quickly fall apart.