It will not have escaped your notice that one of the UK’s best fund managers in the last 20-25 years, Neil Woodford has gone from hero to zero in the last few years. In an unprecedented move trading in his flagship fund, the Woodford Equity Income has been suspended. In investment speak it has been “gated,” meaning investors cannot sell their holdings. It has been all over the news. As many of my clients hold the fund I want to explain what I think is going here and provide some commentary.
Neil Woodford built up his formidable reputation at Invesco Perpetual running the flagship Income and High Income funds. Many of my clients benefitted from outstanding returns over many years. He famously avoided investment in technology companies during the tech bubble and eschewed the banks during and after the financial crisis. His success was based on being a contrarian, a value investor and an excellent stock picker. In 2014 he set up his own investment firm and launched the Woodford Equity Income fund. Investors piled in, in many cases on the advice of their IFAs. Guilty as charged. However things started going wrong a few years ago and since then a variety of companies that Woodford invested in have run into trouble including Provident Financial, Kier and Purple Bricks. He also has had problems with substantial investment in small unquoted technology companies. These carry additional risks compared to large listed companies. For a start unquoted stocks are illiquid, because they are not traded on a stock exchange and fledgling companies run the risk of outright failure. Finally Woodford’s value investment style has been out of favour for a long time although it was his bad stock picks that have primarily been the cause of his demise. Performance has been rotten in the last three years. Data from FE Trustnet (15/6/19) show the fund fell a whopping 21.6% in the 12 months. In contrast the average Investment Association (IA) UK All Companies sector fund fell by 4.0%. Over three years the Woodford Equity Income lost 17.4% compared to a 31.5% rise in the sector average. That is a heck of a difference.
Alarmed at the poor performance, investors started to pull money from the fund. Its assets fell sharply from around £10.2 billion at its peak to £3.7 billion but it was the recent acceleration in the rush for the exit that led to the decision to close it. The problem funds such as unit trusts and open ended investment companies (OEICs) have is unless they hold a substantial amount of cash the manager has to sell stock to meet investor demand. If the market or individual stocks are already falling, forced selling exacerbates losses for investors.
The gating of funds is not new. It has occurred with unit trusts investing in commercial property, notably during the financial crisis and for a brief period after the EU referendum in 2016. Commercial property is an especially illiquid asset and fund managers suspended trading to avoid being forced sellers at terrible prices or because there was simply no market for the properties. I can’t however recall a fund that invests in shares being gated. This is because aside from unquoted companies there is a ready and liquid market for trading stocks on recognised exchanges.
Given the problems with the Woodford Equity Income fund are not new you may well ask why I did not generally advise my clients to sell out, a year or two ago. I took the view like good footballers going through a bad period that “form is temporary but class is permanent.” Having seen my clients enjoy years of outperformance I expected Woodford to come good in the end especially if value investing came back into favour. Clearly like many others I did not appreciate the scale of Woodford’s problems. That said in recent years I recommended clients sell their holdings in the Invesco Income and High Income funds which shared a lot of similarities with the Woodford Equity Income, in order to reduce exposure to the same floundering investment style.
There are several scenarios that might play out in the next few months. Woodford will seek to reposition the portfolio during the suspension, for example to dispose of unquoted stocks and the best case will be that the fund will reopen to dealing in the near future. If Woodford rediscovers his touch we may see positive investment returns in the medium to long term. The worst case scenario is the fund is in terminal decline and will be wound up. Investors will be paid out, in most cases realising significant losses. Another option is the fund could convert to an investment trust, a closed end structure which protects the assets of the fund if investors want to sell their shares. This will be explained in part two of my coverage of investment trusts. Until we know the direction that events will take there is not much more to say. There is nothing we can do at this time.
So what lessons are there from this episode? Star managers can and do lose their Midas touch. That said I cannot recall a fund manager that has had such a spectacular fall from grace as Neil Woodford has. Secondly it is clear IFAs, like myself do occasionally recommend funds that turn out to be duds or even basket cases – disappointing for clients and embarrassing for advisers. I too am an investor in the fund.
At a broader level some will suggest this is a nail in the coffin of active fund management and that investors would be better off solely investing in low cost index trackers or Exchange Traded Funds (ETFs). I beg to differ but that is whole new issue. I do by the way recommend passive funds on occasions. Finally there may be calls for better regulation of fund managers whilst claims management companies may see a new business opportunity in seeking redress, now the PPI debacle is coming to an end in August.
This is an example of fund manager risk, one which can be rarely predicted and a reason why it is essential to diversify a portfolio.
The content of this blog is based on my own understanding of the Woodford Equity Income fund and is intended as general investment commentary only. Nothing in this article should be construed as personal investment advice. You should seek individual advice based on your own financial circumstances before making investment decisions.