A Fallen Star: Neil Woodford

It’s with a heavy heart this week that we learned the news of the suspension of the Woodford Equity Income Fund.

Only a few years ago, Neil Woodford was the shining star of the fund management world. If there ever has been a household name in the fund management world, Neil Woodford surely has to be that name.

To give you some background on what’s happened, the Woodford Equity Income Fund has always had a relatively small proportion of its investments in unlisted or smaller companies. Neil Woodford has always maintained that these companies have incredible growth potential.

The problem with unlisted or small companies is that they are hard to value, illiquid and sometimes hard to sell (especially when under duress as is the case now).

In recent years, the performance of the fund has been very disappointing, to the extent where the Woodford Equity Income Fund has been at the bottom of most league tables for at least two years now.

As a result, investors have been withdrawing money at a fairly rapid rate. This all came to a head last week, when Kent County Council requested 250 million pounds back out of the fund.

When a fund manager gets withdrawal requests of this size, they generally have to sell assets in order to meet the redemption. Given the illiquid nature of some of the assets at the bottom of the portfolio, Neil Woodford has been selling the larger and more liquid companies that sit within the fund in order to meet these redemption’s. As a result, the percentage of smaller and unlisted companies within the portfolio has grown over the past 12 months to the point where it’s exceeded the 10% limit imposed by the regulator.

Neil Woodford then listed some of the smaller holdings within the fund on the Guernsey Stock Exchange and has also exchanged some of the smaller assets within the fund for his own Patient Capital Trust shares (this is an investment trust, also run by Neil Woodford, which specialises in smaller company investments). Many commentators have expressed concern over these actions and how legitimate they are.

Even if they do comply with the letter of the law, I am almost certain they don’t comply with the spirit and indeed the regulator is now investigating these Guernsey Stock market listings.

There are lots of lessons to be learned from this debacle.

First of all, I think it highlights the risks involved in self-investing. Most self-investors use the research and recommendation tools from the broker or the platform that they use to purchase investments.

In this particular case, the Woodford Equity Income Fund was heavily, heavily marketed by some of the biggest names in the self-investing (and advisory for that matter) world. Self-investors bought the fund in their droves and while they may have been aware of the poor performance, I would be surprised if many of them had been aware of the developing liquidity problem within the fund.

Although clearly, I have an element of self interest in promoting the value of professional financial advice. I think it is probably fair to say that the vast majority of self-investors do not have access to the level of information required to make an informed judgment on how suitable the Woodford Equity Income Fund was for their needs, especially as time went on.

What started as a traditional large cap UK equity Income Fund, ended up becoming arguably quite a risky small cap speculative investment. Unless you had your eye on the ball, this shift in style and strategy may not have been obvious.

The vast majority of well-run advisory firms I know (ours included) pulled the fund out of most client portfolios a couple of years back. I recall the Buckingham Gate Investment Committee agonising over what, at the time, felt like quite a controversial decision. “Pulling Neil Woodford out of the portfolio just because of 12 months of under-performance, you must be mad” was uttered to me by one interesting individual at an investment seminar!

2 years later that decision looks incredibly sensible, although I don’t profess to have foreseen the liquidity issues ahead of time. Basically, the data was telling us that there were better options out there, so we followed the data. It is as simple as that.

It seems the only organisations that continued to promote the fund, despite what has now been a very extended period of significant under-performance were those who had too much skin in the game or who had some sort of commercial arrangement with the now embattled fund manager.

I think another issue, which becomes clear here is people getting carried away.

I think it’s fair to say that Neil Woodford probably got a bit over excited when it came to re-positioning the portfolio in line with his once-famous conviction. What started as a slight transition towards some of the smaller and more domestically focused stocks (in the belief that they would out-perform after the Brexit uncertainty fades away – a point on which he could still be proved right, if we can ever break the Brexit impasse), turned into a wholesale shift away from the large-cap income stock on which Woodford made his name into medium and smaller companies, many of which the average investor has probably never heard of.

Finally, there is an air of desperation about the actions taken within the fund. As the performance got worse and worse and the losses got deeper and deeper, it seems that more and more risk was taken within the fund in order to try and recover some of those losses. A strategy which has now failed spectacularly.

What happens next is unclear. The fund is now suspended for 28 days and this may be extended. Given the severe outflows from the Woodford funds over the past week (by my count, he has lost in excess of £4bn this week alone) I wouldn’t be surprised if the fund gets merged into a larger UK equity fund or it could even be wound down.

With all of this said though, things might not be quite as bad as they seem!

The UK regulatory system ring-fences client assets and within an open-ended fund, the value investors receive is simply the value of the underlying assets within the fund. Neil Woodford’s demise doesn’t really do much to change that value, to the extent that share prices come under pressure because he is a forced seller.

When it all boils down though, those who will be most impacted by the suspension and the resulting fallout will be those who did not follow the basic rules of investing in the first place.

Have your money in a range of different funds, from different fund managers.

Diversify across sectors, geographies, assets classes and strategies.

Don’t take more risk than you need to.

Continually monitor and review your investments.

These rules have worked for the past couple of hundred years and I suspect they will continue to do so. It is those who don’t follow the rules who get hurt!

"The value of investments and the income from them may fall as well as rise. You may get back less than you originally invested"