Investors in the suspended Woodford Equity Income Fund are hoping it will reopen and that everyone who wants their money back will get it straight away. Unfortunately, we doubt that will happen. Moreover, we would argue that the fund should not reopen as normal. Here’s why.
Although the Woodford Equity Income Fund is a retail investment fund that has been sold to the general public with daily dealing, we would argue that, in its current condition, the fund actually resembles a hedge fund. Why? Well, according to the fund’s accounts, the fund has lots of investments that are very thinly traded, some that are not traded at all, and some for which it is hard even to establish a price. If the Woodford vehicle were a hedge fund, it is likely that it would have required investors to give 90 days’ notice if they wanted their money back, not the daily redemptions of the Woodford fund.
The Woodford fund was suspended on 3rd June “until further notice”1, with Woodford stating that the suspension would be reviewed at least every 28 days. In the initial 28-day period, the fund manager will of course be working to raise as much liquidity as possible by selling what can be sold. But based on the liquidity analysis released for end-April 20192, we predict that this activity is unlikely to realise much more than one-third of the value of the fund. If the fund were to reopen after 28 days, outstanding redemptions would be met from this one-third.
The problem is that while some investors would get their money back, those who decided to stay would find that the remainder of the fund contained an even greater share of illiquid investments, many of which would not have a market price. Based on the last annual accounts, only 60% of holdings in the Woodford Equity Income Fund were valued by “a quoted price in an active market”. The remaining 40% were subject to a variety of valuation techniques3.
If the Woodford vehicle were a hedge fund, the likely solution would be to split the fund in two to create what is known as a side pocket. The 40% of the fund that is not liquid and/or hard to price would be put into the side pocket. The fund manager would declare that this portion could not be redeemed. The main fund would reopen, at 60% of its former size, and pay out redemptions from the sale of the more liquid assets. The side pocket would only pay out later, when its holdings were sold.
Creating this kind of structure in a retail fund would be highly complex but it would be in the best interests of investors because it would mean all investors would be treated equally. Those who wanted out would get a good share of their money back relatively quickly while the fund’s illiquid investments would not be traded at fire-sale prices but sold off slowly.
It is hard to predict what happens next. Woodford and Link Fund Solutions, the authorised corporate director of the fund, will be in discussions with the Financial Conduct Authority, which may issue guidance. To us, it seems extremely likely that the suspension will be maintained in early July for at least another 28 days.
Bad news for investors in the fund.
A different approach
Nutmeg has no exposure to the Woodford Equity Income Fund. In fact, we never invest in this kind of actively managed fund, which aims to beat the broad market by stock picking. Instead, we invest in portfolios of exchange-traded funds (ETFs) which typically track whole indices, such as the FTSE 100. Because they are listed on exchanges, ETFs can usually be bought and sold quickly on any day the markets are open. It is important for us that both the funds we invest in, and the underlying assets they hold, are highly liquid.
Other advantages of ETFs are that they are low cost. By making our investment process as cost-efficient as possible, we pass on more returns to our customers. Finally, ETFs are transparent, which means we know exactly what we are investing our customers’ money in.
If you would like to learn more about our investment process, please contact us today.
- Information on the Woodford Equity Income Fund’s liquidity profile included in a Financial Conduct Authority letter to MP Nicky Morgan dated 18th June https://www.fca.org.uk/publication/correspondence/lf-woodford-equity-income-fund-letter-tsc.pdf
- Woodford Equity Income Fund Annual Report 2018, page 53. Level 1 Fair Value Hierarchy accounted for 60% of assets at 31/12/18. https://static.woodfordfunds.net/prd/2019/05/LF-WEIF_Annual-Report_181231.pdf
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