The Woodford case: When nervous investors sit on illiquid investments

The impending collapse of the Woodford Equity Income Fund (WEIF) in the UK may not only cost (ex-)star fund manager Neil Woodford his company. The crisis also casts a shadow over the increasingly popular illiquid investments, especially among institutional investors, and their supervision.

The case of Neil Woodford, who is currently holding British investors, the media and financial regulators in suspense, can be told from three perspectives: as a drama of the rise and fall of a former star fund manager, as evidence of the carelessness of supervisors, or as a harbinger of the difficulties of active asset managers when they juggle illiquid investments. Above all, however, it is a warning of how reluctantly the key players in the affair communicate.

So, what happened?

Neil Woodford, who after 26 years at Invesco became self-employed in2014 with his company Woodford Investment Management, was popular with investors. Both the large institutional investors such as St. James’s Place and Kent County Council pension fund, but also with many small investors who were busy investing in his flagship fund, the Woodford Equity Income Fund (WEIF), through the leading UK retail fund platform Hargreaves Lansdown.

“His approach, based on bespoke research, gut feeling and a taste for going against the grain, divided opinion,” writes The Economist about Woodford. But the investors in the United Kingdom trusted him: within a short time, Woodford managed to raise the WEIF to a volume of around GBP 10 billion. Around 1.6 billion of these were parked directly or indirectly with Hargreaves Lansdown clients at the end of March – and brought the fund platform a substantial profit margin.

Woodford’s style of investing in large, dividend paying corporations (Blue Chips) changed over time. The manager increasingly relied on the supposed winners of tomorrow: small, partly not even listed and illiquid companies with a focus on the British domestic market. But his risky bets didn’t work, his performance was mixed, and investors withdrew a lot of money from the WEIF.

At the beginning of June, the fund was down to GBP 3.7 billion and when Kent County Council was to withdraw its GBP 263 million mandate on 3 June, the WEIF was blocked from repayments. This freeze remains in place. Comments from Woodford’s firm suggest that it will be maintained for months until the fund has released enough cash to pay out impatient investors.

Market expectations are that investors will flee the WEIF in droves as soon as they are able to do so again. From Woodford’s second fund, the Woodford Income Focus Fund (WIFF), investors withdrew GBP 116 million within ten days by mid-June. Market observers are now publicly questioning whether Woodford’s firm will survive the loss of assets and confidence.

However, what was the downfall of Woodford’s, with his often-down-to-earth appearance, was not his poor performance, Financial Times columnist Merryn Somerset Webb says. Rather, it was a whole series of cardinal mistakes: “Mr. Woodford took too much money too fast. He believed his own hype, forgetting that the team around him at Invesco and particularly its risk management and compliance controls might have been helping him out. But, worst of all, he mixed and changed styles.”

Financial supervision embarrassed

Woodford’s crisis has now spread, embarrassing both Hargreaves Lansdown and the UK Financial Conduct Authority (FCA).

The Chief Executive  of the fund platform, Chris Hill, first had to publicly apologise for why Hargreaves had not earlier removed the WEIF – despite the persistently poor performance and doubts arising from its liquidity –  from his “Wealth 50” recommendation list. Two days later, Hargreaves waived the platform fees for the fund.

Another day later, Nicky Morgan, Chair of the UK Parliament’s Treasury Committee, said that investors should not pay any management fees at all for the WEIF, as long as it is blocked. And while Neil Woodford has so far refused to comply, Hargreaves Lansdown CEO Hill has taken personal action and said he would be waiving his GBP 2.1 million bonus.

„The actors in Woodford’s investment drama haven’t made any effort to quickly clarify and communicate.“

Morgan and Members of Parliament (for a change not immersed in trench warfare over Brexit) ask FCA the unpleasant question: “Did the supervision sleep at the wheel when the fund manager went into the crisis?” Meanwhile, Morgan has announced a parliamentary inquiry into fees and transparency of the entire fund industry. For FCA boss Andrew Bailey, the Woodford case could turn into a career snap: His candidacy to succeed Mark Carney as the Head of the Bank of England will be given little chance.

Whether Woodford, Hill or Bailey – the key players in this investment drama haven’t made any effort to quickly inform and communicate with investors.

Head of Bank of England warns against illiquid funds

It was Carney, by the way, who only recently again pointed out the dangers of illiquid funds: At a meeting in Tokyo, the Governor of the Bank of England warned against investment funds that promise their customers daily liquidity, but invest some of their capital in illiquid investments – around USD 30 trillion have already been invested in such funds, Carney said.

The Woodford case thus also casts a shadow over the liquidity of investments such as private debt or real assets, which are particularly popular among institutional investors in times of low interest rates.

Stable, predictable returns from long-term investments – who would say no to that? However, it becomes problematic if investors unexpectedly want to withdraw from these investments, but pay-outs are blocked … Just remember the crisis of open-ended real estate funds in Germany in 2008 and in Great Britain shortly after the Brexit vote in 2016.

In October last year, the FCA published a 79-page advisory paper on the risk of illiquid investments, which was updated in April. Michael Busack, editor of the German institutional magazine Absolute report, put it in a nutshell in the foreword to the current issue: “Nothing is more dangerous than an illiquid investment that has to be sold under pressure and possibly with the knowledge of other market participants”.