One remedy to come out of the FCA asset management market study is that the authorised corporate director (ACD) must appoint at least two independent directors to their board or 25%, depending on which is higher. The requirement comes into effect this September.
Larger listed fund groups, like Schroders and Legal & General Investment Management, tend to act as their own ACD, while smaller boutiques like Lindsell Train and Woodford Investment Management outsource this function to external companies like Link Fund Solutions and Valu Trac Investment Management.
Shiv Taneja, founder and CEO of Fund Boards Council, says “we could not have had a better case study than the Woodford situation” to prove why better governance in the fund industry is needed.
Who has the guts to stand up to Woodford?
Gbi2 managing director Graham Bentley says having an outsider with “the guts” to challenge the portfolio manager running the mandate, especially one with the clout and star power of Woodford, is critical.
Bentley says: “You then get in that position, if you don’t have independent directors, of who is going to challenge? Who has the guts?”
As the ACD on Woodford’s fund, Link would be responsible for ensuring the new rules regarding independent directors are met when the FCA requirements come into force later this year.
Nick Britton head of intermediary communications at the Association of Investment Companies says the FCA’s push for independent directors on fund boards “has got to be a step in the right direction” and will help bring the governance of Oeics in line with investment trusts, which have fully independent boards.
But he wonders if the requirement of having one quarter of the board made up of independent directors goes far enough. “They could be overruled. But it doesn’t mean, of course, that they couldn’t raise concerns and put pressure on.”
Taneja says it is difficult to say “with any complete certainty” that were there independent directors sitting on the fund board of Woodford Equity Income or the ACD was internal that none of these issues would have happened.
However, Taneja says compliance and risk management is as much an internal executive function as the governance oversight provided by the ACD.
“I think you have to consider the individual circumstances of the organisation. We’re talking about an individual who had the reputation that Neil Woodford has or had, we’re talking about, the organisation was set up by him in his own name, it was run very closely by a very small number of people including himself.”
Directors clueless on liquidity risks
Jon ‘JB’ Beckett, ambassador for the Transparency Task Force, is also dubious that non-executive directors to the fund board overseeing Woodford’s fund could have made a difference.
In his experience “very few” fund directors understand complex topics like liquidity risk.
“I’m actually asking them specific questions around liquidity, capacity, exposure to unlisted positions and scalability. Everything that’s kind of coming off the back of Woodford,” says Beckett, who himself sits on the fund board of a small boutique asset manager as an independent non-executive director.
“All these things I would suggest very few fund directors understand. That’s not good at all, because that’s when the same mistakes get repeated every time.”
That’s why he says the FCA initiative to bring laypeople and industry outsiders into non-executive roles has the potential to backfire.
Third time’s a charm
Link acquired Capita Financial Managers in 2017, which had problems of its own. It was fined £66m by the UK regulator for the blow-up of the Connaught Income fund and presided over the Arch Cru scandal where 20,000 retail investors were trapped in a group of funds.
“Many directors and non-executives are not going to understand how liquidity would affect Woodford’s portfolio when the fund was so large, to understand how liquidity would change his portfolio, to understand how he would have to respond to redemptions and also where he was positioned in the market cycle,” says Beckett.
“That requires a good level of technicality, but also understanding the inherent liquidity of those underlying markets. Once you start to understand those, then you’ve got a chance you can actually challenge the board.”
Cash began trickling out of Woodford Equity Income in 2016, with redemptions becoming more consistent and gathering pace the following year. The fund ended 2017 with net outflows totalling £1.32bn and by 2018 this figure had nearly doubled to £2.38bn, data from Morningstar shows.
Despite the FCA and Link meeting monthly to monitor the “deteriorating liquidity position” of Woodford’s fund from April 2018, Link did not begin sending the regulator daily liquidity reports until a year later.
At that point 65% of the portfolio was held in assets that Link classified as harder to trade with a third predicted to take between 180 and 365+ days to sell out of.
They’ve seen things go wrong before
In light of the recent high-profile fund issues around liquidity Britton says this is an area directors will pay more attention to in future.
The AIC code of corporate governance requires directors on investment trust boards to carry out robust assessments of risks that might threaten the company’s business model future performance like solvency, reputation and even liquidity, though he says this is less of a risk for closed-ended vehicles.
“I wouldn’t like to say that having a board is the answer to everything and nothing bad will ever happen but they do provide this extra layer of oversight,” says Britton.
“Some of these people on boards are impressively experienced and they’ve seen things go wrong before, let’s be frank. They have a knowledge of the kind of things that can go wrong, but they have a duty to look at the risks that could be faced by the company. If they are the right people, and they are doing their job right, this is the kind of thing they should be looking at.”