Fundsmith founder Terry Smith has shone a spotlight on the role platforms played in driving demand for daily-dealing open-ended funds that contributed to the Woodford Equity Income fund suspension.
In the final pages of his annual letter to Fundsmith Equity investors, which is primarily focused on the performance of the fund, Smith examined various issues at play in Neil Woodford’s demise.
“It seems impossible to comment upon developments in equity investing in the UK in 2019 without mentioning the word Woodford,” the global equities manager said, stating he had previously avoided doing so out of courtesy to the fellow high-profile fund manager but now saw no way he could exacerbate the situation further.
Platforms demand daily-dealing funds
Smith detailed a number of issues he thought had contributed to Woodford’s problems, but highlighted one for slipping under the radar in the extensive coverage of the fund suspension.
He said: “Amongst the causes which commentators seem to have failed to realise is the effect which the rise of investment platforms has had on this, and indeed other areas of the fund management industry.
“It is now the case that no one can expect to effectively market an open-ended fund on any of the major investment platforms which retail investors and wealth managers use to manage their investments unless it is a daily-dealing fund.
“As none of these platforms will admit an open-ended fund, unless it allows daily-dealing, that is what fund managers will use even for strategies for which this structure is wholly inappropriate.”
The Bank of England is currently in the process of assessing the financial stability affects of liquidity mismatch in daily-dealing open-ended funds. The FCA released its rules on the issues in the midst of the Woodford fallout but was criticised for not taking a harder line.
Fundsmith liquidity
Smith described the mixture of unquoted and small-cap holdings in a daily-dealing open-ended fund as a “lethal combination” that gives investors the illusion of liquidity. But a large number of redemptions from such funds is comparable to shouting “fire” in a crowded theatre, he said.
Fundsmith would be able to liquidate 57% of its portfolio in a week and its average market cap is £114bn, he pointed out. FTSE 100 companies InterContinental Hotels, Intertek and Sage were the least liquid holdings in the fund.
While arguing cash is the only 100% liquid investment, he added it would be “hard to find more liquid equity funds than ours”.
Terry Smith argues against tarring all star fund managers
Smith also said not all star fund managers should be tarred with the same brush, even though he pointed out he was not a fan of a term the press “seems obsessed by”.
Using the analogy of star athletes trying their hand in a different sport, he said Woodford’s investment approach had drifted significantly from the sector bets on large-cap names that earned him his reputation.
“When he opened his own fund management business he took positions in a wide range of companies — AA, AstraZeneca, Capita, Imperial Brands, Provident Financial and Stobart are some examples,” he said.
“There is no common theme that I can detect to those companies, other than the fact that they all subsequently fared badly. This was supplemented by a raft of unquoted investments in start-ups and biotech.”
He added: “The problem wasn’t that he was regarded as a star but that he changed his game.”
Fundsmith had no desire to change, he added, pointing out that investors could scrutinise that through the fund boutique’s annual letters and its annual meeting.
