In the aftermath of the Woodford scandal, it’s time the industry did better

As many of us sadly predicted, the administrator of the suspended Woodford Equity Income Fund has decided the fund will not reopen. In our view this outcome was inevitable from the moment the Financial Conduct Authority (FCA) revealed the extent of the fund’s liquidity problems. We had previously warned that in the best interests of preserving Woodford investors’ capital, it may make sense to wind the fund down. Although we agree this step is necessary, nevertheless it is a sad and sorry conclusion for the hundreds of thousands of retail investors who now face an even longer, and more uncertain wait for their funds.

Since the suspension, the extent of the illiquid holdings in the portfolio – as well as the creative measures the manager took to try to get around illiquidity limits – have become clearer. The FCA has launched an investigation into the events that led to the fund’s suspension, and it will be critical for the industry and regulator to learn lessons from this damaging episode. Neil Woodford himself has rightly faced scrutiny. His firm courted controversy by refusing to waive fees on the fund while it was suspended, thereby receiving fee income of some £65,000 a day while investors were locked out from getting their money. It seems to us that the Woodford saga has severely dented trust in the investment business. 

Perhaps the worst part of the Woodford fiasco? Terrible performance

Throughout the period of suspension, Woodford has stressed that the repositioning was not a “fire sale”. Unfortunately, there has already been a stark effect on performance. Since the fund was suspended on 3rd June, the FTSE All Share index has returned 2.76%. The Woodford Equity Income Fund meanwhile has returned a negative 15.55% over the same period. That indicates that an investor in the fund with £10,000 at the time of suspension would have just £8,445 remaining – and they still cannot access their money. Unfortunately, the losses could continue if the administrator is forced to sell the remaining assets at a discount to raise capital.

But that’s not even half of it. The true extent to which Woodford investors have already suffered is staggering. Over 12 months, the fund trails the FTSE All Share index by -34.66%, over three years it has underperformed by -53.14%, and over five years by a damning -61.36%. Investors in the fund shouldn’t just be asking when they will receive their funds back, they should ask how and why they were recommended this fund in the first place. Platforms and wealth managers that offered the product to investors should face questions over their due diligence and sales practices, in particular how this fund appeared for so long in “best buy lists”.

What happens next? Time to learn lessons

The plans for wind-up of the Woodford Equity Income Fund are set to follow our predictions. The fund’s portfolio will be split in two. BlackRock, one of the world’s largest asset managers, will oversee the winding up of the part that contains the listed stocks. PJT Partners, a spin-off of Blackstone Group, will handle the unlisted assets.

This means Neil Woodford’s role in the management of the fund named after him is over with immediate effect. Disappointingly for his investors, the wind-up of the fund will not be a quick process. It is likely to take months if not years, with investors receiving their capital back in instalments.

Clearly, this is bad news for investors in the fund. But is this an opportunity for the industry as a whole to improve? We hope so. Here’s what we’d like to see:

• An end to the myth of the “star manager”. Both academic studies and studies of active managers’ performance have demonstrated that choosing a manager that will outperform is incredibly difficult. Yet the industry continues to push the story of star managers. At Nutmeg, we build globally diversified portfolios using exchange-traded funds (ETFs). We never put our trust in the “skill” of individual stock pickers.
• Much higher scrutiny of “best buy” lists. The Woodford saga calls into question the partiality of fund platforms that recommend certain funds above others. At Nutmeg, we do not believe best buy lists are an effective tool for helping retail investors.
• More transparency. Strange as it seems now, the Woodford Equity Income Fund was once considered more transparent in an industry that didn’t have a good reputation for openness; most UK investment funds only reveal their top ten holdings on a monthly basis, for example. At Nutmeg, we think customers should be able to know exactly what they are invested in. See our commitment to transparency for more information.

What Nutmeg can do for you

The decline of the Woodford Equity Income Fund is not a time for schadenfreude but an opportunity for investment businesses of all types to reflect and improve. Here at Nutmeg, we examined the Woodford fund’s liquidity problems in depth to see if we could learn lessons from the fund’s failure. We concluded that our investment process, built using highly liquid ETFs and with a focus on diversification, helps us to avoid the kinds of liquidity problems that affected Woodford and others. We also believe the structure of ETFs means they offer our clients multiple sources of liquidity, meaning it is less likely that they would ever need to be “gated”, even in the worst market conditions. Nevertheless, there is always room for improvement, and as a result of the Woodford scandal we made a new promise to our customers – that any customer who wants one can have a full breakdown of all the underlying securities in their portfolio.

Our investment process at Nutmeg was designed to be transparent, liquid and, importantly, low cost. We think that’s in the best interests of our customers and, ultimately, of the investment industry too.

Sources

1. Bloomberg data
2. Bloomberg, net total return in GBP to 14/10/2019
3. https://woodford.linkfundsolutions.co.uk/media/yr2dbqm2/15th-october-2019-investor-letter-regarding-the-winding-up-of-the-lf-woodford-equity-income-fund.pdf

Risk warning

As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. A stocks and shares ISA may not be right for everyone and tax rules may change in the future. If you are unsure if an ISA is the right choice for you, please seek financial advice. Past performance is not a reliable indicator of future performance.