As 2019 draws to a close, the biggest name the UK fund management industry has seen for decades, Neil Woodford, is weeks away from beginning the process of officially winding down the first fund he launched after setting out on his own.
He had been expecting to re-open Woodford Equity Income at the end of the year, before the fund’s authorised corporate director, Link, pulled the rug out from under him in October, setting off a chain reaction that resulted in the suspension of his second equity income fund – Woodford Income Focus – and ultimately the closure of his eponymous boutique.
Though many believed it was game over for Woodford when he was caught quietly trying to list a handful of his unquoted stocks on the Guernsey stock exchange, no one could appreciate how much of an impact the flameout of one of the industry’s biggest stars would have.
Woodford story starts with one man but tarnishes entire industry
The level of public scrutiny that has been targeted at the asset management industry since Woodford Equity Income was suspended is “unprecedented”, according to David Masters, head of PR agency Lansons’ alternatives and institutional practice.
“This is a story that starts with the reputation of one man and ultimately becomes about the reputation of the entire industry,” he says.
Stories of macho cultures and sexual harassment claims at some of the biggest fund groups, SJP’s ‘cruise and cufflinks’ rewards system and allegations of the greenwashing of high-profile ethical funds from Legal & General and Vanguard have all come to light since the Woodford crisis, and have been subsequently splashed across the pages of the national newspapers.
Such stories reveal an industry that is in crisis – and which is suffering from poor governance, poor controls and poor culture, says Masters. “For anyone who says our industry has got a bit of a PR problem, they are misunderstanding the scale of the problem fundamentally or at least they are misrepresenting it. It’s a behavioural problem. And reputation ultimately is defined by your behaviour.”
The asset management industry has done “a rubbish job” of articulating how and where it adds value, says Transparency Task Force founder Andy Agathangelou.
“And that’s why I think this Woodford situation has resulted in such huge bad publicity, because it’s not like the bad publicity is competing against some well-articulated statement of purpose,” he says. “It’s actually pushing against an open door.”
Reputational damage hits UK asset managers in the pockets
Amid this climate of public distrust and ongoing Brexit uncertainty, active fund managers have been severely punished.
Data from the Investment Association shows £11bn has flown out of retail and institutional funds in the 12 months to 30 September 2019, representing around £100m in fees out the door.
Chelsea Financial Services managing director Darius McDermott believes the Woodford saga has done a lot of damage. “This will have put another generation of savers potentially off investing into equities at a time when that’s exactly what they need to be doing for their long-term future.”
Since Woodford Equity Income suspended, £4.9bn has exited from UK-domiciled equity funds. In total, retail funds have attracted net inflows of £2.8bn between 1 June and 30 September, compared with £4.2bn during the first five months of this year.
The asset management industry is a harshly competitive environment in which providers are selling variations of the same products and services, trying to make a case for why clients should park their money with them.
Did Woodford’s star status blind fund pickers to liquidity problems?
One of the ways it has done this historically is via the narrative of the star manager. Before Woodford there was Anthony Bolton of Fidelity. Now, managers Terry Smith and Nick Train are seeing their stars on the rise. Mark Mobius, who has been romantically described as the Indiana Jones of emerging market investing, still has the clout to draw investors to his new venture.
But having a manager with such an imposing status can blind advisers, fund selectors, the media and even people within their own organisation from seeing potential red flags.
Woodford’s liquidity issues are nothing new. Two years ago, Portfolio Adviser published a feature where I called out his practice of owning such massive stakes in both listed and unlisted companies.
At the time, Woodford and his Invesco protégé, Mark Barnett, were the largest joint shareholders in a slew of companies from logistics firm Eddie Stobart, now on the brink of collapse, as well as less liquid IP firm Allied Minds and a Russian warehouse investor.
When Provident Financial – the pair owned more than 40% between them – had £1.75bn wiped off its market cap in a single day of trading, the article queried whether Woodford would have been able to sell out of his investment had he wanted to or cope with a stream of redemptions.
Peter Sleep, senior portfolio manager at Seven Investment Management, says these concerns were there when Woodford was running money for Invesco. Taking a look at Invesco Income in 2011, Sleep was concerned to discover the number of small and unquoted companies in his fund.
And yet Woodford’s investment business was approved by the regulator in record time, despite his former employer Invesco having been fined £18.6m by the FCA for derivatives breaches involving Woodford’s funds.
Fund giants could have an advantage in age of SMCR
The thorny issue of culture is something the regulator has been trying to get to grips with recently, says Masters.
The senior managers and certification regime, which comes into effect this month, is one way the FCA has tried to make individuals at fund groups more accountable for their actions.
“The problem is that a lot of asset management firms are trying to realign that culture, but really as a compliance exercise, and nothing more than that,” he says. “If all you’re trying to do to improve your culture is tick a series of boxes then you’re going to fail, because all the regulator can do is set the minimum standard.”
But rolling out stricter guidelines around risk and compliance could disproportionately affect smaller investment businesses, according to Adrian Lowcock, head of personal investing at Willis Owen.
“The risk and compliance issue has the potential to affect boutique businesses where the departments are policing the owner, which generates a conflict of interest,” he says. “This is the area that needs to be looked at closely with the regulator working with boutiques to improve processes. It would be a shame if so many good and well managed boutiques are tarred with the same brush.”
Sleep agrees that post-Woodford investors might gravitate toward bigger brands such as Blackrock “that have the checks and balances to rein in the next Woodford”.
How to measure fund liquidity
As it happens, Woodford Equity Income’s authorised corporate director has tasked Blackrock with disposing of the listed stocks in the soon-to-be-wound-up fund, while the Woodford Patient Capital trust has been handed to another giant to run – Schroders.
Both fund groups are rumoured contenders to take over Woodford Income Focus as well.
Liquidity in open-ended funds, which are almost exclusively daily dealing, will inevitably be a focal point moving forward. Sleep expects there will be more scrutiny on all open-ended fund liquidity, with pressure from fund selectors, authorised corporate directors and the regulator.
But he says trying to measure liquidity accurately and write meaningful regulation around it “is like trying to nail jelly to the wall”.
The liquidity of a security changes over time and while it’s easier to measure liquidity for equities where all trades are centrally reported, for other asset classes like bonds, which are still traded over the counter, it can be “notoriously difficult”, says Sleep.
“We could end up with liquidity regulation like the Securities and Exchange Commission’s (SEC), where a management company is asked to put a fund’s assets into liquidity buckets: three days or less; three to seven days; a bucket that can probably be sold in three to seven days but may require longer; and an illiquid bucket. The SEC also asks for someone to take personal responsibility for a fund’s liquidity.”
Best thinking from AIFMD would help funds deal with liquidity
The events leading up to the suspension of Woodford Equity Income have already challenged fund boards appointed by the authorised corporate director to reassess the way they think about liquidity, says Jonathan Beckett, former fund selector and independent funds board director.
Fund boards, which now must include at least two independent non-executive directors, are focusing more on investor profile, redemption risk, cashflows and how this matches the liquidity of the portfolio, he says.
Beckett says it’s not about pushing fund managers to hold the most liquid stocks but reviewing liquidity against the expected aims of the fund. Small and mid-cap managers will take longer to trade their positions without excessive spreads, for example.
“What independent non-executive directors will want to understand is whether the trend is one of deteriorating liquidity or if some assets are questionable against fund aims and liquidity risk.
“As Woodford showed, simply trading out the most liquid positions first creates a bigger issue if redemptions continue before a portfolio can rebalance. Changing the liquidity and risk profile of any fund to cover redemptions should be avoided.
“Monitoring the liquidity of not just assets at the extremes but also in the meat of the portfolio is essential.
“To this end, simply reporting and acting upon Ucits thresholds is not enough. Expanding oversight to pull together best thinking from the Alternative Investment Fund Managers Directive regime and Fair Value Pricing Standards is of value.”
Hargreaves’ role in driving investors towards Woodford
The Woodford saga has also re-opened discussions around the blurred lines between financial advice and other forms of guidance.
Several class action suits have been launched against D2C giant Hargreaves Lansdown, which flogged Woodford Equity Income via its Wealth 50 list despite admitting it had misgivings about the level of unquoted and hard-to-trade assets since late 2017.
CWC Research director Clive Waller likens the differentiation between advice and guidance to “Orwellian newspeak”.
“Everyone else in the world knows advice and guidance are the same thing except the regulator,” he says. “But that’s why IFAs like it, because it keeps everybody out of their business. They also differentiate between personal advice and non-personal advice. Well, sorry, the customer doesn’t.”
