'Woodford mess shines fresh light on regulators'

Neil Woodford. Picture: Woodford Investment Management/PA Wire

Hype and high finance simply do not go well together.

You would have thought that this lesson had been learned after the financial crash, but not so, it would seem.

Last week, another investment hero came crashing unceremoniously to earth when Englishman Neil Woodford announced the suspension of withdrawals of funds by investors from his flagship Woodford Equity Income Fund, which he has run since 2014.

Mr Woodford has been a star name in the world of finance; regarded by some as an English equivalent of the legendary stock picker Warren Buffett. His decision has been slated in the media. The Daily Mail has referred to investors in the flagship fund affected by the suspension as "hostages."

While some are large funds, many more are small investors.

The actual trigger event was the decision – currently thwarted – by Kent County Council to withdraw its holding, believed to be worth £263m (€295m), in his Equity Income Fund. According to one newspaper report, the investors in question will not be able to make a withdrawal before Christmas.

The event is the culmination of a long series of withdrawals by investors concerned at the poor rate of returns being generated.

Two years ago, the value of the Fund peaked at just over £10bn. By the end of May, the figure stood at £3.8bn and withdrawals were averaging £380m a month, according to media reports.

Woodford has had to sell liquid assets held in publicly-quoted companies. The problem is that the Fund is also invested in companies, many of them privately-owned, which are far less liquid. This, in turn, has meant that those retaining their investments in the Fund are left with a collection of holdings in their portfolio which are both riskier and less easily encashed.

The UK public body charged with regulating the sector – the Financial Conduct Authority- has been sharply criticised for failing to act to protect the investors who now find themselves exposed. Mr Woodford and his colleague, Craig Newman, have been slated over the huge sums extracted by them in the form of dividends and profits. Daily Mail commentator, Alex Brummer, has put the figure at almost £97m over a period of four years.

The pair are coming under pressure to waive the management charges and fees which their customers are continuing to bear. The annual charge on monies invested in the Fund ranges between 0.65% and 0.75% - adding to as much as 7.5% over a decade.

The former City Minister, Lord Myners – who served in this job at the height of the financial crisis – has described the FCA as being like "the scene of crime investigators who arrive after the damage is done."

In his view, they "did not anticipate events despite the clear warning signs."

In an interview with the BBC, he pointed to the role of Link Fund Solutions, the Woodford Fund’s supervisor, appointed at the behest of Mr Woodford himself.

The fund management industry has argued against [the appointment of ] independent directors. There is nobody watching the fund managers and saying – 'wait a minute, this is getting too risky'.

Mr Woodford made his name with a company called Invesco Perpetual which he joined in 1988. After years of successful stock picking, he ended up managing £25bn on behalf of pension funds and other investors. A person who placed £1,000 with Invesco back in 1988 would have seen the value of their investment rise to £23,000 by the time he left the company in 2013.

Tremors are being felt across the funds industry, with the leading investment broker Hargreaves Lansdown, in particular, coming under fire for introducing clients to Woodford despite an investment strategy which has proven to be unsuited to the needs of investors not in a position to lock away funds for the long haul.

When Mr Woodford set up his holding company Woodford Investment Management, he could do no wrong. Shares in Invesco, his former employer, actually fell by 7% after he announced his departure.

The firm operated out of an industrial estate near Oxford, running a number of funds. The location was unusual as was his decision to pay his top employees high salaries rather than the stellar performance bonuses common in the City of London.

A devotee of Warren Buffett, Mr Woodford is a so-called "value investor" who departed from the usual fund management practice of tracking indices – following the herd , in other words. His approach was to include in his portfolio a selection of investments in smaller firms with high potential – as he saw it. The approach worked well for a while, with returns of 16% being generated in 2015.

Then came the Brexit referendum vote of June 2016 and a series of events at specific investee companies - which, between them, have exposed the flaws of the Woodford strategy.

There was, however, plenty of logic behind his strategy. According to Nick Wood, head of research with Quilter Cheviot, the distinction between publicly-listed stocks and private equity has become blurred. With increasing amounts of capital flowing into private markets, the funding requirements of private companies are being satisfied without the need to have recourse to a public listing.

Fund managers have been investing in private companies in the expectation that they will generate greater longer term returns. Many consider that much of the cream will have already been skimmed off by insiders by the time a public flotation has occurred.

The problem is that Mr Woodford appears to have lost his touch when it comes to stock selection. He also gambled on a quicker resolution to the Brexit referendum vote conundrum than has turned out to be the case. Among his turkey investments you have construction Group, Kier – its share price crashed by 40% in one day, a week ago. Woodford has a 20% stake in Kier.

He was also heavily invested in Provident Financial – share price down by 80% in two years; and Capita, down 70%.

Mr Woodford, himself resurfaced on his website to tell his investors that he had taken the ‘difficult decision’ to freeze activity in the Equity Income Fund in order to "protect" investors following "a lot of outflows."

As he put it, the stock market "anticipated that we would sell stock to meet the redemptions and we felt that the price we could achieve [for the stock] would not be sufficient."

The vultures were circling, in other words. He also pointed out that his Woodford Focus Fund was not affected by this decision. Woodford is not the first star name to plummet from favour.

The real lesson for investors, here, is not that London is a dodgy place in which to place funds. The City remains a repository for vast amounts of talent, but the unfortunate reality is financiers – no matter how stellar their reputations – are prone to error and the objects of temptation.

Success can deprive people of a sense of reality. Regulators need to be well ahead of the curve and ready to spot the signs. This clearly did not happen in the case of Woodford’s equity fund and now, thousands – including many overseas investors - must sweat over the final outcome.

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