Woodford trades hint at a liquidity problem

With Neil Woodford’s equity income fund continuing to shrink amid hits to his holdings, investors and analysts are again questioning whether unquoted investments in an open-ended fund are a square-peg round-hole situation.

Woodford traders hint at a liquidity problem

Revelations over the weekend the star fund manager had decided to sell out of AJ Bell ahead of its flotation and shun Atom Bank’s rights issue has raised eyebrows.

Already this year, Woodford’s flagship equity income fund has suffered £1.3bn worth of outflows. Woodford’s flagship equity income fund has returned -10.4% and 3.05% on a one-year and three-year view respectively. The fund currently stands at £6.9bn, a substantial drop from its £10.1bn position at the beginning of 2017.

Previously, Portfolio Adviser has asked whether Woodford, and his ex-colleague Mark Barnett who now runs his old strategies at Invesco Perpetual, are engaged in a risky game of liquidity by taking such big positions in small, illiquid companies.

Given the heavyweight manager has been forced to make some tough calls around his long-term investments, including ditching his £40m stake in AJ Bell, now seems an appropriate time as ever to revisit this question: is Woodford’s predilection for fledgling start-ups incompatible with an open-ended fund structure?

Inexplicable trades

“I don’t understand it, why would he sell out after holding it for so long?” asks Ben Yearsley, director of Shore Financial Planning, on Woodford’s decision to drop his stake in investment platform AJ Bell ahead of its planned listing on the London Stock Exchange.

On whether Woodford’s move was dictated by liquidity concerns, Yearsley responds, “It’s got to be, hasn’t it?”

He thinks it comes back to the problem of holding unquoted investments in open-ended funds, which is the reason why he ultimately sold out of Woodford’s equity income vehicle last summer.

When the fund is growing, holding unlisted securities “doesn’t matter”, says Yearsley, “but when the fund is shrinking you’ve got a problem, you’ve got to sell it, you’re forced into it, you’ve got no choice.”

Nathan Sweeney, who co-manages the Architas multi-asset active fund and multi-manager UK equity fund ranges, agrees that Woodford’s decision to sell out of AJ Bell and to opt out of the £150m Atom Bank rights issue is a consequence of the liquidity balancing act.

The Financial Times reported last month that Woodford’s equity income fund was close to breaching the 10% hard limit on unlisted securities for retail Ucits funds.

As the value of his listed investments tumble the weighting of Woodford’s illiquid investments has risen, putting him at risk of a “passive breach” of the FCA’s limit.

Provident Financial and Capita have both announced multi-million pound rights issues, which have triggered share price falls, and roadside recovery insurer AA incurred the wrath of shareholders after cutting its dividend.

Because the fund is an open-ended Ucits investing in early-stage companies, this is an issue that Woodford will find himself coming up against.

“If he was seeing inflows would he have supported that [Atom] rights issue? I suspect that maybe he would have, it’s just that he’s in the unfortunate circumstance where he’s seeing heavy outflows,” Sweeney said.

Interest rate sensitivity

Architas was among the crop of high-profile investors that decided to pull money from Woodford’s flagship fund last year, alongside fund of funds investor Jupiter Merlin and Aviva’s workplace pension platform.

But Sweeney says the decision to fully divest the fund from its £920m multi-asset fund range and UK multi-manager fund had more to do with the “opportunity cost” than liquidity issues.

The team has been selling out of income funds in the UK, US and Europe as the beginning of a rate rise cycle across developed markets takes hold. In this environment, the Woodford Equity Income fund’s bias toward sectors like tobacco and healthcare, which are sensitive to interest rate activity, look less attractive, explains Sweeney.

Flashing red lights

Recently, Woodford has been banging the drum about tech bubbles and other such “red flashing lights” but Sweeney doesn’t believe markets will turn bearish anytime soon.

“Arguably we’re nowhere near [a correction] there,” he says.

“A lot of people have got very jittery that the market sold off over the last few weeks. We haven’t had a correction in a very long time but the numbers that came out of the US on Friday have confirmed that everything is good.”

Instead, Sweeney believes “we’re moving away from central banks to company fundamentals.”

In the US, “you’ve got low unemployment, people working, which is going to create growth in the economy, and there is no wage inflation so that means companies don’t have to pay away their profits for their fixed costs.”

All this points to a rosy picture for equities, particularly growth style equities, not Woodford’s value-style investments.

Historically, Woodford’s fund has thrived in periods of prolonged market underperformance.

“Companies who deliver will do well and companies who don’t like some of the names that Woodford held (ie Provident Financial) will not. You will see more disparity between winners and losers.”

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