What can investors learn from Neil Woodford’s downfall?

Once a media darling and widely hailed as one of the UK’s top fund managers, Neil Woodford experienced a dramatic downfall this year that has been the focus of hundreds of stories by financial news outlets trying to understand how it all went wrong for his investments – and his clients’ portfolios. 

In mid-October, the disgraced fund manager announced the closure of Woodford Investment Management. The company’s flagship fund, which in 2015 stood at £6.7bn and is now at £3bn, is being liquidated. Since early June, when Woodford first made the drastic decision to suspend all trading in the Equity Income fund after its poor performance led to a flood of redemptions that couldn’t be paid, the fund manager had been working to reduce the fund’s exposure to unlisted, illiquid investments.

After many retail investors saw the value of their investments in the Equity Income fund plummet, the immediate fallout from the trading suspension was that investors could not withdraw their funds. This has led to concerns from the Bank of England, the UK Treasury and others in industry about the risks posed by Woodford’s structuring of liquidity. 

The impact on Woodford’s investment trust, Woodford Patient Capital, caused its share value to fall by more than 50% since the end of May. As of last week, however, its shares rebounded by 30% after Schroders Investment Management [SDR] said it will take over as manager of the trust by the end of the year, renaming it in the process.

Fund services company Link Fund Solutions, which is the Equity Income fund’s administrator, said in a statement: “After careful consideration, the decision has now been taken not to reopen the [Woodford Equity Income] fund and instead to wind it up as soon as practicable. This is with a view to returning cash to investors at the earliest opportunity.” 

Investors in the Equity Income fund can expect to receive some of their money from January next year, but the full timeline for the fund’s total liquidation remains uncertain. One thing that is clear, though, is that Woodford no longer manages the fund. 

In response to Link’s statement, Woodford said: “This was Link’s decision and one I cannot accept, nor believe, is in the long-term interests of LF Woodford Equity Income fund investors.”

 

The rise and fall

Woodford, one of the UK’s best-known stock pickers, left his position at Invesco to launch Woodford Investment Management in 2014. In doing so, he managed to get some industry heavyweights to back the new venture with plenty of cash. 

He became known as “the man who can’t stop making money”, and Woodford Patient Capital became the biggest UK investment trust after it raised £800m in 2015. Kent County Council had more than £200m of its pension fund invested in the Equity Income fund. 

  

Woodford’s close relationships with intermediaries such as St James’s Place and Hargreaves Lansdown helped him attract a steady flow of funds for his investment vehicles. Hargreaves Lansdown [HL], in particular, has since faced scrutiny regarding its close relationship with Woodford. According to a report by the Wall Street Journal, Hargreaves Lansdown secured discounts on Woodford’s products and Woodford gained from the fund supermarket’s promotion of the fund manager’s products. 

By the end of 2018, worrying cracks were beginning to show. Over the first half of this year, the poor performance of Woodford’s investments led clients, which included some large institutional investors, to start withdrawing their funds in droves. At one point, the flagship fund was seeing outflows of around £10mn a day, the Financial Times reported. 

To pay the investors wanting their money back, Woodford had to resort to selling the fund’s liquid shares in listed companies. As a result, that left the Equity Income fund with a greater proportion of hard-to-sell, or illiquid, holdings. When Kent County Council tried to recoup its £263mn investment in the flagship fund, Woodford did not have the money to pay it, leading to the fund’s suspension on 3 June.  

“I personally deeply regret the impact events have had on individuals who placed their faith in Woodford Investment Management and invested in our funds,” the fund manager stated following the closure of the fund and ultimately the company.

“I personally deeply regret the impact events have had on individuals who placed their faith in Woodford Investment Management and invested in our funds” - Neil Woodford

 

Earlier this week, fund manager Robin Geffen told Citywire that the income sector was in “a very dangerous position” where the top 10 stocks on the FTSE All-Share Index contribute more than 50% of the yield. According to Geffen, a large number of income funds had become “fixated” on these stocks, ratcheting up what he calls a “very high dividend risk” – that a large portion of their yield is from holding large positions in a few very high dividend-paying stocks.

 

Let the blame game begin

According to Bank of England governor Mark Carney, open-ended funds investing in illiquid assets, such as Woodford’s Equity Income fund, are “built on a lie”, as they are unable to provide investors with the ability to make daily redemptions. Such liquidity issues, as well as Woodford’s investment strategy, have raised some uncomfortable questions for Link, intermediaries St James’s Place [STJ] and Hargreaves Lansdown, and even for the Financial Conduct Authority. 

Investment industry veteran Jonathan Little told the Financial Times: “If there is anything good to come out of this, it is that investors will move away from the industry’s Hollywood-style culture of star worship.”

“If there is anything good to come out of this, it is that investors will move away from the industry’s Hollywood-style culture of star worship” - Jonathan Little

 

In addition, the downfall of Woodford has again raised the debate about passive versus active management. With many investors involved in passive investing, the argument from the active side has always been that a fund managed by an individual with professional expertise can be far more agile in volatile markets than index-tracking funds.

One of the main concerns with active management is a fund manager’s performance that becomes consistently weak. This can be incredibly costly in many respects, not only in terms of the actual investment losses incurred, but also when taking into account management fees, which can add up to a huge sum of money over a long period. 

Data compiled by S&P Global found that 90% of active funds across Europe delivered inferior returns to index-tracking competitors in the year to June 2019. UK funds, in particular, were beaten by benchmarks over 50% of the time over one-, five- and 10-year periods. 

  

The post-Woodford world

BlackRock [BLK] has been appointed to help manage the liquidation of the Equity Income fund, alongside PJT Partners. Woodford’s investment trust will be taken over by Schroders by the end of the year and be renamed Schroder UK Public Private Trust. 

“Schroders will be a good outcome for the trust’s management, as I trust their judgement for stock selection and risk control, which the previous incumbent Neil Woodford doesn’t seem to appreciate or even comprehend,” an investor in Woodford Patient Capital Trust, Ian Hunter, told the Financial Times.

“Schroders will be a good outcome for the trust’s management, as I trust their judgement for stock selection and risk control, which the previous incumbent Neil Woodford doesn’t seem to appreciate or even comprehend” - investor in Woodford Patient Capital Trust, Ian Hunter

 

The key development for investors will be how regulatory bodies try to address all the issues that led to the end of Woodford’s investment empire.