The name uppermost in the mind of every adviser, investor, financial journalist and fund manager at the moment is surely that of Neil Woodford. The past few months have been challenging for him, to say the least.
To understand these events, we need to go back a few years to find out what went wrong and who could be held responsible – the manager, the regulator, or its authorised corporate director.
Woodford Investment Management began to see outflows from the Woodford Equity Income fund in late 2017. During the year, performance started to struggle after several blows from major holdings including Provident Financial, biotechnology firm Circassia and Allied Minds, a technology company. Jupiter’s Merlin team – its multi-asset funds – pulled £300m out of the fund without an explanation at the time.
Head of the Merlin team John Chatfeild-Roberts has since explained in a presentation to fund investors that there was a policy to say “absolutely nothing” about why it was sold.
He added: “The reason was we were very worried that there would be a run on the fund…. We realised if there was a run on the fund bad things would happen, and that is exactly what happened and we didn’t want anything to do with that.”
Chatfeild-Roberts told investors the team had “lost confidence” with what was happening with the fund, particularly regarding the number of unquoted shares. He said that, when the initial investment was made, there had been six unquoted companies, but by the time it was sold there were 45.
"If a manager completely changes direction, I will sell, which is what I did with Woodford"
As 2018 progressed, it was clear that the outflows were not stopping. Many UK equity income funds suffered with outflows, given turbulent markets predominantly due to Brexit.
In January 2019, the fund was included for the first time in Best- invest’s ‘dog funds’ list of worst-performing funds, where it was described as one of the worst. However, Hargreaves Lansdown continued to promote the fund and reiterate its confidence in the manager.
In May, HL head of research Mark Dampier said: “This isn’t the first time in his career Woodford has underperformed. We’ve stuck with him during difficult times before, and in the past investors have been rewarded for such patience. Our analysis of Woodford’s long-term record gives us the confidence to retain the Equity Income fund on the Wealth 50 [HL fund buy list], and we think he’s still got the skill to deliver excellent long-term performance.”
HL investors were reminded that “Patience is a virtue,” with Dampier adding: “The alternative of frequently chopping and changing your portfolio to chase performance is likely to be damaging in the long term.”
Fast-forward just one month to 3 June and the story was very different. It was announced all investor dealing in the Woodford Equity Income fund would be suspended following a decision from its ACD, Link Fund Solutions.
Initially, it was stated the fund would remain suspended for 28 days until it could sell off some of its unquoted shares. However, after some extensions, it was announced in October that the fund would be completely wound up “as soon as practicable”.
Expert view: Discretionary approach assists with flexibility
The events surrounding Neil Woodford have refocused minds on liquidity, just as we saw when various property funds were gated in 2016. This in turn poses the question of whether advisory or discretionary portfolios are best placed to respond to such situations, and what other related factors should be considered.
When problems arise, the operational responsiveness of a discretionary fund manager approach can be only a positive. Of course, the convenience of the DFM approach is beneficial only prior to a fund’s suspension, and even then it’s worth considering whether the additional costs are commensurate with that upside.
For what it’s worth, around 75 per cent of assets on the Nucleus wrap are managed on an advisory basis, typically in models where the portfolio construction is provided by a third party. When we discuss the relatively low take-up of DFM-managed portfolios with advisers, most respond that pricing is prohibitively expensive.
The spread between the cost of procuring intellectual property and the cost of most managed portfolio services is considered absurdly wide – depending on the size of an adviser’s business and different DFMs, it’s not unusual for clients to effectively be paying more than 25-30 basis points for the administrative convenience of a discretionary approach. This feels very difficult to justify, and that’s long before you get close to understanding whether a given DFM is any good.
It seems to me the discretionary approach assists with flexibility and administrative convenience, but fees are a real problem. No one wants to see clients getting stuck in problem assets (for whatever reason) but, for those targeting outcomes that can stretch over several decades, the corrosive impact of excessive fees over a sustained period is perhaps even more damaging.
The optimum outcome is probably a low-cost discretionary service driven by client outcomes, which can respond promptly when things go wrong and which aggressively pursues value for money (in the DFM fee and the underlying assets) over the long term.
David Ferguson is chief executive of Nucleus
Woodford himself said in a statement: “This was Link’s decision and one I cannot accept, nor believe is in the long-term interests of LF Woodford Equity Income fund investors.”
Link said it had been in “close discussions” with the regulator about winding up the fund completely and this would commence on 17 January 2020.
It would not be possible to start the process any earlier due to the requirement to give three months’ notice under the applicable European directive and as implemented into FCA rules, Link added.
Woodford was fired as the fund’s manager on 15 October and Link has appointed PJT Partners as its specialist broker to assist in selling the unlisted and illiquid assets.
BlackRock Advisors will wind up the listed assets and will use the proceeds to purchase money market funds and FTSE 100 instruments. Link says this activity is to “enable us to return part of investors’ cash as soon as possible once the fund begins the winding-up process”.
On the same day as being fired, Woodford was also removed as manager of the Woodford Patient Capital Trust. Shortly after that announcement by the board, Woodford said: “I personally deeply regret the impact events have had on individuals who placed their faith in Woodford Investment Management and invested in our funds.”
Just one day later, it was announced that Woodford Investment Management would shut down completely.
"I expect fund managers to stick to what they are good at"
Did we see it coming?
In a video address to his investors in September 2017 titled ‘Has Woodford lost it?’, the fund manager pledged to stick to his investment style. But Morningstar analysis shows the fund changed from a large-cap growth-style fund to a small-cap core fund as per its categories.
There are many reasons this could have happened, including the idea the manager was forced to sell off his larger, more liquid holdings to cover any redemptions from the past year, or through external circumstances.
Shore Financial director Ben Yearsley says: “I expect fund managers to stick to what they are good at.
“So, if I’m buying a large-cap value fund, that’s what it should do. In most markets I try and pair the best value managers with the best growth managers – it’s not always possible, but in lots of areas it is.”
He adds: “If a manager completely changes direction, I will sell, which is what I did with Woodford.”
What now for Patient?
A month after the suspension of the Equity Income fund, the board of the Patient Capital Trust announced it would be searching potentially for a new manager of the investment trust.
Last week, it was announced Schroders would be managing the mandate. Chair of the board Susan Searle said: “Following a competitive process, we are delighted to be appointing Schroders as the company’s portfolio manager.
“Its careful and considered long-term approach to investment, backed by its substantial research resources in both public and private assets, makes it the natural choice to manage the company’s portfolio.”
The fund will be renamed the Schroder UK Public Private Trust plc. Analysts from Numis thought it understandable that the board had opted for an ongoing strategy, rather than a managed wind-down, because of the difficulty and potential valuation impact of the unquoted companies held.
The change of management will come with a price attached, however. Woodford famously did not charge an annual management fee for the trust, but Schroders will now charge 1 per cent per annum with additional performance fees.
Yearsley calls the fee arrangement “quite generous” for the asset manager, “especially after the pain shareholders have been through”.
Willis Owen head of personal investing Adrian Lowcock says it is “as good an outcome as possible” for shareholders and will “draw a line” under the Woodford saga.
He adds: “Our only concern is the high fees. Naturally, investing in private equity will come with additional costs, but the fund will eventually have both a performance fee and an annual management fee. That said, investors will have more than three years, until the end of 2022, before they have to worry about the charges.”
The market also reacted positively to the news as the trust shares jumped 30 per cent following the announcement.
Adviser view: Check the small print
Ian Watson Independent financial planner Alexander Beard Wealth
Without fully scrutinising Woodford’s individual stock dealing it is hard to be categorical, but I wonder if he was deported rather than migrated.
First, the delineation between a growth stock and income stock may not be absolute. Woodford did very well on both counts for a decade or two. Can a stock be classed as both at any time?
How many investors, professionals included, actually checked his fund mandates where his approach was, or should have been, clearly stated? Again, it is not Woodford’s fault if some (sometimes complacent) IFAs, and/or their clients, did not check the small print.
Equity markets generally are fickle and often driven by factors outside our field of vision, and certainly outside our control. Woodford almost certainly had confidence, whether misplaced, in all his stock selections, but neither he, with all his years of knowledge and experience, nor anyone else could ever predict with certainty which ones would rise or fall more or less than others.
Tiptoeing around requirements
We now know that the FCA was in touch with the Woodford Equity Income fund last year regarding the rule that states open-ended funds can hold a maximum of 10 per cent of their net asset value in illiquid assets.
The regulator stepped in when the illiquid holdings in the fund stood at 10.3 per cent, in February 2018. The fund managed to get the proportion below 10 per cent, but the number jumped back above it two months later. Since then, the fund has been under the FCA’s liquidity watch.
When FCA chief executive Andrew Bailey spoke about this in front of the Treasury select committee in July this year, he said: “Listing something on an exchange where trading doesn’t happen, as far as I can see, doesn’t actually count as liquidity.”
This was a clear reference to listings on the Guernsey-based The International Stock Exchange.
However, Woodford listed some of his stakes on the TISE during
the time the fund was under the watchdog’s eye. His stake in property developer Sabina Estate was admitted to the TISE in 2017 and the stake in Ombu Group on 15 June 2018; Industrial Heat was bought on 5 October 2018.
According to the FCA’s preliminary supervisory enquiries, the fund’s exposure to unlisted securities was around 20 per cent in February this year. The regulator has not said Woodford breached any rules regarding the 10 per cent limitations.
Listings including Benevolent AI, Industrial Heat and Ombu were all suspended on 11 April this year.
The TISE made several attempts to contact the FCA about this, initially receiving no response. TISE managing director Mark Nicol said: “This is a regulatory matter that is confidential in nature and therefore I am unable to make any further comment at this time.”
However, Bailey later revealed the suspensions were due to “press reporting and queries about whether the listings had led to a breach of any FCA regulations”.
The suspension of shares did not affect their status as quoted, and therefore did not change the ratio of listed versus unlisted companies in the fund.
The FCA understands that Woodford responded to the request to get the holding below the 10 per cent threshold by using rules including one that allowed a security to be excluded from the 10 per cent limit if its issuer planned to list that security within 12 months.
Most companies shout from the rooftops when they go public, but these didn’t
Stock rating service Stockopedia’s strategies editor, Ben Hobson, says: “The Guernsey listings look to have been a direct result of Woodford trying to reduce his exposure to unquoted securities but still retain them as holdings in the fund.
He adds: “There was no access to financial information about those firms, which really makes it look like those companies didn’t want to have any active trading in their shares. Most companies shout from the rooftops when they go public, but these didn’t.”
Fees: what we know
What will this cost investors?
There will be no change to fees until the start of the winding-up of funds.
What do fees cover?
Fees will cover BlackRock’s fees as well as those for the fund’s depositary, administrator, custodian and auditor. Link Fund Solutions will not take a fee for acting as authorised corporate director from the point of suspension (15 October) and, if there is a surplus of other fees, it will be returned to the fund.
Brokerage and legal costs will be borne by the fund. Link says: “These costs will be greater during this period than they were typically in previous periods due to the requirement to sell all of the fund’s assets.”
Will investors have to pay tax?
Depending on the size of investment, potentially yes. Link says proceeds from the winding-up of the fund will be deemed to be part-disposals of investor shares in the fund for capital gains tax purposes and may give rise to a CGT liability. It suggests investors in the fund should “seek professional advice” if they are in any doubt over tax consequences.
What will Woodford earn?
The FT’s analysis on 28 October shows Neil Woodford and his business partner, Craig Newman, could rake in dividends of nearly £20m for the past financial year.
A case for segregated mandates
The saga could see the case for segregated mandates emerge victorious.
During the year, Woodford was removed as manager of segregated mandates on behalf of Quilter, St James’s Place and Omnis, Openwork’s asset management arm. Quilter removed him in April while SJP and Omnis both dropped him in June.
Next Wealth managing director Heather Hopkins says: “The additional oversight and control was a real endorsement for the approach taken by Omnis and SJP.
“Both customised the mandates, so they didn’t have the same exposure to the same illiquid and unlisted securities. They were also able to swap managers quickly so that their customers’ money was not locked in the closed fund.”
The SJP Equity Income fund’s £3.5bn mandate restricted Woodford to picking any stocks listed within the FTSE 350, alongside a 20 per cent overseas flexibility with a $5bn (£3.9bn) market cap. Liquidity issues were not a threat here, unlike in Woodford’s native fund.
Therefore, because these funds did not face an imminent risk of gating, kicking Woodford out was regarded by analysts as a knee-jerk reaction to the negative press the manager was experiencing at the time, and as a bid to control reputation.
As the suspension of the mandated funds was unlikely, the other side of the argument may be that the regulator’s restriction applied in the first place would have prevented Woodford drifting to illiquid waters.
Next Wealth research from May this year found that mandate changes rarely happen. It states: “Among the 106 funds managed using segregated mandates that we reviewed for our analysis, only 13 had changed the management firm (two changed individual manager within a firm).”
Neil Woodford joins Invesco Perpetual.
Invesco Perpetual High Income fund suffers as a result of tech stock crash; rebounds after two years.
Woodford leaves Invesco and passes management to Mark Barnett; launches Woodford Investment Management later in the year. St James’s Place portfolios are transferred on day one; Equity Income fund is launched. Woodford becomes first manager to list full holdings.
Equity Income fund surpasses High Income in size, reaching £6.7bn by the end of July. Woodford Patient Capital Trust becomes largest fundraising for a UK investment trust, raising £800m.
Woodford Equity Income Focus launched; remit of Patient Capital Trust shifts to invest in more unlisted companies and more outside the UK. Jupiter pulls £300m from Equity Income fund.
Outflows begin following a series of underperformances.
9 January 2019
Fund remains on Hargreaves Lansdown’s Wealth 50 best-buy list.
9 February 2019
Fund appears on Bestinvest’s Spot the Dog fund list of worst performers
3 May 2019
HL says Woodford has “the skill to deliver excellent long-term performance” and it is sticking by him.
3 June 2019
Equity Income fund suspended “for 28 days” following a string of redemptions; Equity Income and Income Focus both removed from HL Wealth 50.
23 September 2019
Fund suspension extended; Link said to be targeting a December reopening.
15 October 2019
Announcement that fund will be wound up; Woodford is sacked as manager of Patient Capital Trust.
16 October 2019
Woodford Investment Management announces it will close.
As the winding-up of the fund has yet to take place, it is still unclear how much money investors will be able to reclaim.
Fees have also been a contentious issue for many observers as the manager refused to back down on fund charges despite the fund’s suspension.
“The company will continue to charge a management fee as we focus on repositioning the portfolio, to cover the infrastructure and resource costs associated with running an actively managed fund,” it said.
However, analysis by the Financial Times on 28 October estimated that Woodford and his business partner, Craig Newman, might pocket almost £20m in dividends for the past financial year despite failures at the firm.
Link says fees will remain in place until the process to wind up the fund begins. The amount accrued in fees alone between 3 June and 15 October was £184,034 a day.
Alongside fees, regulation is a widely discussed topic. The FCA has yet to release any of its findings from its probe into the fund’s management, which it launched a few weeks after the fund’s initial suspension.
In an interview with The Times, the FCA’s Bailey said: “The suggestion we did nothing was wide of the mark.”
He also highlighted problems with having both retail and institutional investors in a fund – for example, Jupiter’s Merlin funds.
One consequence is the FCA has confirmed it will launch a new class of illiquid shares for retail investors after an initial consultation last year.