5 Jun 2019

Woodford Equity Income suspension

Woodford Equity Income Fund has never been on our recommended list Woodford Equity Income Fund is not held within discretionary portfolios managed for clients on Standard Life, Nucleus, Transact or Parmenion platforms.

Woodford Equity Income suspension

  • Woodford Equity Income Fund has never been on our recommended list
  • Woodford Equity Income Fund is not held within discretionary portfolios managed for clients on Standard Life, Nucleus, Transact or Parmenion platforms

Woodford Investment Management’s major fund, Woodford Equity Income, suspended dealings on Monday 3rd June and will probably remain closed for four weeks.  The £3.7 billion fund had shrunk from over £10 billion at its peak due to poor performance over the past three years.

The fund’s authorised corporate depositary, Link  Fund Solutions, is responsible for ensuring that investors are treated fairly when a fund has problems selling investments to meet its investors’ demands for cash. The rules permit it to keep the fund closed for up to 28 days, after which it must obtain the regulator’s approval for any further suspension.

Investors will be unable to sell their units in the fund until the suspension is lifted.

The manager’s other open-ended fund, Woodford Income Focus, remains open for dealings. Woodford Patient Capital (an investment trust), is not affected.

Neil Woodford said in a video update to investors: "It has happened because of an increased level of redemptions, and then the stock market anticipating that this would lead to us having to sell stocks, we felt the prices we would be able to achieve for those sales would be disadvantageous to investors, so we felt that suspending the fund gives us the time and space to execute the strategy, which is to have no unquoted stocks by the end of the year.

"The capital will be reinvested in FTSE 350 and FTSE 100 stocks that fit in with our strategy but are also very liquid.”

FiveWays Financial Planning has never recommended any of Woodford’s funds to investors, and none of Woodford’s funds are held within the discretionary portfolios managed for FiveWays’ clients on Standard Life, Nucleus, Transact or Parmenion platforms.

Our view was and is that Neil Woodford was taking too much risk with his Equity Income Fund. We think it is unwise for managers of open-ended funds, which allow investors to buy and sell every day, to hold unlisted investments, for which accurate valuations can be hard to ascertain. We believe investors wanting to hold such investments should buy investment trusts, which have permanent capital and do not have to redeem investors’ shares on demand.

Below we answer key questions about the fund suspension

Why has the fund been suspended?

At its launch in June 2014, Woodford Equity Income owned mainly shares in giant businesses like Imperial Brands. But manager Neil Woodford was convinced that smaller businesses offered far better opportunities to investors and invested an increasing proportion of the fund’s assets in mid-sized and smaller companies. This was not a problem while the fund was growing in size, but when it started to shrink, shares in these smaller companies proved hard to sell.

The fund was also in danger of breaching a regulatory limit: a maximum of 10% of assets may be invested in companies without a stock market listing. In this situation, the rules require dealings to be suspended. Otherwise, some investors are likely to benefit at the expense of others.

Why has performance been so poor?

Over the three years to the end of May, Woodford Equity Income’s total return (including reinvested net income) was - 17% compared with an average of +23.6% for all authorised funds in its peer group (IA UK All Companies) (source: Financial Express).

A major reason was poor performance of many of the funds’ largest holdings, including Imperial Brands, AA, Provident Capital, Capita and Kier.

Neil Woodford was convinced that after Brexit, UK-focused businesses would have a strong recovery after a period of declining share prices. But the delay to Brexit means that even if he is right, the light at the end of the tunnel is further away.

What role have unlisted investments played?

Woodford Equity Income held nearly 10% of its investments - the regulatory limit - in companies that had no stock market listing.  Today, it is likely the percentage has exceeded that level.

As investors withdrew capital from the fund - with its value shrinking from £10 billion two years ago to under £4 billion today - the managers struggled to reduce the unlisted investments to remain within the limit.

Since other investors know that the fund is under pressure and is a ‘forced seller’, it is hard for the managers to obtain a fair price for these investments. A period of suspension is intended to allow the manager to change the investment portfolio so that it can manage further redemptions. Whether this will be possible with Woodford Equity Income is an open question, since when dealings resume many more investors are likely to want to sell.

What has the regulator done?

Ultimately the Financial Conduct Authority is responsible for the regulation of UK open-ended funds like Woodford Equity Income. The FCA does not comment on ongoing situations, but commentators have pointed out that it was made aware of the problems at the fund over a year ago. Questions will certainly be asked about what it has done in the meantime.

What about Hargreaves Lansdown?

The investment platform Hargreaves Lansdown was Woodford’s biggest supporter, and its investors own almost 40% of Woodford Equity Income and 60% of Woodford Income Focus. Several of HL’s own managed funds also own the fund, including HL Income and Growth, a £2.9bn fund that holds over £400m in Woodford funds.

HL negotiated a fee of 0.5% for Woodford Equity Income for its own investors compared with the standard 0.75% charged to others. Questions were raised when in January HL kept Woodford Equity Income on its Wealth 50 list despite its poor performance.

How frequent are fund suspensions?

One of the main aims of a regulated funds regime is to avoid suspensions: if investors do not have confidence that they can buy and sell at any time, they will not invest at all.  So maintaining ‘liquidity’ is a key aim for a fund regulator.

After the EU referendum in 2016, a few open-ended funds investing in UK property suspended dealings for several months as nobody could be sure what the real value of commercial property was. The Financial Conduct Authority recently reviewed these suspensions but suggested only minor modifications to the funds regime that most commentators think will do little to prevent similar suspensions in future.

In the financial crisis in 2008, a few funds investing in higher-risk corporate bond briefly suspended dealings.

Prior to that, the last big case was the suspension of Morgan Grenfell European Growth in 1996, after fund manager Peter Young artificially inflated the fund’s performance figures. Over 80,000 investors got compensation.

Woodford Equity Income suspension

Not on the basis of the fund’s poor performance: that is one of the normal risks of investing. Even good investment managers sometimes get it wrong. But if investors are shown to have lost because of mismanagement of the fund’s liquidity, including its unlisted investments, they might have a case for compensation.

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