Andrew Bailey’s recent comments about splitting retail and institutional investors in the same fund has highlighted the dangers of supertanker investors suddenly pulling large sums of money from pooled funds, as seen with Kent Pension Fund’s role in the collapse of the Woodford Equity Income fund (WEIF).
The Financial Conduct Authority boss said last week the implosion of Woodford’s fund empire had led him to think whether mixing the two types of investor is a good idea because “having a redemption period that doesn’t match the liquidity of the assets is odd to dangerous”.
WEIF was suspended by its administrator Link Fund Solutions in June after the Kent sought to withdraw its £263m investment and Bailey pointed to this request as “the very proximate cause” of the freezing of the fund.
In contrast, Jupiter Merlin has been praised within the industry for its exit from the fund several years earlier, which was done in several stages.
Bailey’s comments come at a time when liquidity in open-ended funds is under the regulatory spotlight in the wake of the Woodford crisis and the gating of property funds following the Brexit referendum in June 2016. The regulator is seeking to address the issue but came under fire in September for failing to include Ucits funds, such as Woodford’s, in its measures to address liquidity risk in retail funds.
The watchdog’s thoughts also reignite fears over retail and institutional investors investing alongside each other and in the case of Kent in particular, begs the question why it did not have a segregated mandate from the get-go.
Why did Kent not have a segregated mandate?
GBI2 managing director Graham Bentley says the approach taken by Kent, or its advisers, smacks of “putting five grand into an Isa” when it should have thought harder about the potential implications for other investors from investing such a large sum in a pooled vehicle.
“If you have such a large slug of money that you want to give to a manager, the question needs to be: how do you best protect the interests of your members, clients or whatever? Normally you would say, ‘We would like you to run some money for us separately and there’s going to be certain rules about what you can and can’t buy because of our liquidity; we don’t want to share our exposure with anybody else’.”
Bentley suspects the reason Kent opted for the pooled fund was because it was easier to buy such a vehicle than to get a manager to run a separate mandate, despite the costs of the latter usually being lower.
Independent non-executive director and author Jon ‘JB’ Beckett has observed institutional investors moving towards Ucits over segregated mandates to benefit from the controls and perceived ease of withdrawal with Ucits. He also notes asset managers have sought to promote funds over mandates to fund economies of scale.
“Often asset owners liked the feeling of being pooled in a larger fund. Mandates are traditionally more difficult to move money out of, but institutional investors may want to review whether open-ended funds offer value over contractually robust mandates,” he says.
‘Ucits is not an on/off switch’
Investors were surprised when Kent asked for the entire £263m in one go when other supertanker investors in Woodford, such as Jupiter Merlin, dealt with it differently without causing panic. Other investors with segregated mandates with the manager included St James’s Place and Omnis, both of which seemingly terminated these with little issue.
Bentley describes Kent’s decision to ask for all its money back as “interesting”, because in his experience holders with a significant commitment to a fund usually recognise the impact they could have if they were to suddenly sell.
“They want to protect the interests of their members by taking the money out, but also don’t want to inadvertently punish holders who have nothing to do with them. To do that you agree to have a steady redemption rate.”
As such, the fund manager and exiting investor might agree between themselves to allow the manager time to get liquidity into the fund, that is by holding onto cash that’s coming in rather than buying stock with it.
Bentley says the episode begs the question how closely performance was being monitored by Kent’s advisers. It also raises questions about the extent to which the power of the Woodford brand was influencing decisions rather than cold, hard analysis of the empirical data.
Beckett says what is needed is the increased rigour of pension scheme decisions, into and out of funds, which is driven largely by the large investment consultants who act as fund gatekeepers. Kent was advised by Hymans Robertson until 2018 before Mercer stepped in on an ad hoc basis.
He notes Kent’s redemption request may have been the inadvertent consequence of the Competition and Markets Authority investigation into the institutional investment consultancy industry which identified conflicts of interest, a lack of competition and opaque fees.
Beckett adds: “Institutional investors already know that to move large tickets you need to work with the fund manager to avoid disrupting the portfolio, and to avoid large cash drag or dilution or swing pricing. This can take weeks if not months and likely happen in tranches.
“The actions and timing of some large holders look questionable. A Ucits is not an on/off switch; better appreciation of the assets, trading and settlement is needed.”
How to exit a large position correctly
Jupiter Merlin could be held as the poster child for how to exit a large investment in a pooled fund. It invested shortly after the launch of Equity Income in 2014 and amassed a £1bn position, considerably more than Kent’s £263m, but rather than pull the entire amount in one go, it wound down the investment over time culminating in the £300m it pulled from the fund in September 2017, as first reported by Portfolio Adviser.
Fairview Investing investment consultant Gavin Haynes says the Jupiter Merlin took “exactly the right approach” to its Woodford exit. He says it was the model of how a manager who has large exposure to a fund should manage its withdrawal to protect both its own investors and those remaining in the underlying fund.
Portfolio Adviser contacted the Kent Pension Fund but it declined to comment on its decision to invest in Woodford via a collective vehicle or its reasons for requesting its investment back in one go. We also contacted Hymans Robertson which says it has a policy not to comment on articles relating to former or current clients.
Similarly, a spokesperson for Mercer says: “Mercer was engaged, in 2018, to provide ad hoc investment consultancy services to Kent County Council. As a matter of course, we do not comment on the investment decisions made by clients.”
