The last ten days has seen a lot of media attention on one of the UK’s best known fund managers, Neil Woodford. His flagship equity income fund has suspended dealing, locking in investors until further notice.
To be clear from the outset, EQ Investors (EQ) reviewed the fund offerings from Woodford Investment Management, but decided against adding their funds to our buy list. As a consequence, there are no EQ clients with exposure to Woodford funds through our portfolios.
We made our decision back in January 2016, as we believed his passion lay in improving access to capital for the small, innovation focused companies he had come to know in the UK. As such, we maintained higher conviction in other managers for our investments in listed UK equities.
Who is Neil Woodford?
Neil Woodford rose to fame at Invesco Perpetual, a fund management house that he joined in 1988. He earned his reputation over a 25 year tenure at Invesco, where he successfully avoided the worst effects of the 1990’s dot.com bubble and the 2008 financial crisis.
In 2014, he left his role as head of UK equities at Invesco Perpetual to set up Woodford Investment Management LLP., where he launched the Woodford Equity Income Fund that mirrored his fund management style developed at Invesco. In 2015 he also launched the Woodford Patient Capital investment trust and in 2017 the Woodford Income Focus fund.
He is as an active, long-term equity investor following the ‘value’ investment style first advocated by Benjamin Graham and David Dodd back in 1934 and followed by other well-known investors such as the Berkshire Hathaway chairman Warren Buffet.
What went wrong?
As one of the highest profile independent fund house launches in recent years, Woodford amassed over £11 billion of assets to manage on behalf of investors across a number of funds.
Along with the majority of active managers in 2016, the relative return of his flagship Equity Income Fund versus passive index trackers started to come under significant pressure. Around mid-2017 he chose to reflect his bullish view on the UK economy by increasing his exposure to smaller companies within his portfolios, but it was also around this time when he started receiving redemption requests from investors. Since then, he has consistently returned around £100 million per month with assets now down around 66% from their peak.
One of the interesting features of Woodford’s strategy and indeed the genesis of the launch of the Woodford Patient Capital Trust, was the investments made in private, unquoted companies. These are unlisted companies that do not trade on regular stock exchanges for a variety of reasons such as being too small or simply not needing to do so. There are several benefits to being active in this part of the market, but the single biggest risk is that of liquidity. It is not quick or easy to sell unquoted companies since the market is private and there is no stock exchange through which to sell shares.
It is for this reason that ‘open ended’ funds typically have limits in place for the proportion of unquoted or illiquid holdings that can be owned. When a fund is shrinking in size, these illiquid positions become an ever increasing problem as they grow relative to the size of liquid positions that need to be sold in the market to raise cash for investors.
This is not a problem for ‘closed ended’ funds like UK Investment Trusts, such as Woodford Patient Capital Trust. Investors wishing to exit investment trusts sell their shares directly to the market. A general rule of thumb is the bigger and/ or more popular an investment trust is, the more liquidity it will have as there will be others in the market willing to buy shares from sellers. It is possible that large investment trusts become unpopular and difficult to sell and it is possible that smaller investment trusts are very popular and easy to sell.
In the case of Woodford’s flagship fund, shareholder outflows were so severe that the proportion of unquoted securities had grown significantly and he was bumping up against the FCA limit of 10%. Woodford and the independent corporate directors were therefore forced to take the nuclear option of suspending dealing in the fund.
Lessons to be learned
Such measures are extreme and certainly not taken lightly, although we do believe this decision has been taken with the best interests of investors.
This case highlights the dangers of investing in illiquid assets and why it sometimes pays to ignore the hype.