“More than $30 trillion of global assets are held in investment funds that promise daily liquidity to investors despite investing in potentially illiquid underlying assets.”
~ Mark Carney’s speech in Tokyo, 2019-06-06
Rarely has a point been made in such a timely manner. Three days before, Neil Woodford’s flagship fund, his Equity Income fund, had barred the exit door to Kent County Council who tried to withdraw £263m, freezing all withdrawals. The fund now has £3.7bn AuM, down from £10.2bn two years ago.
This case appears to be a failure of governance and risk control. Being the single named person at the helm of the fund, the pressure to perform rested solely on Mr. Woodford’s shoulders. This was initially very successful, beating benchmarks and attracting billions of investment. But the lack of normal restraints — layers of compliance teams, other managers debating and agreeing strategy, and a separate risk committee — allowed Mr Woodford to invest in riskier, unlisted stocks away from the blue chip companies that had made his name.
“He needed a compliance department of the scale he had at Invesco, but he had people around him who were scared of saying those stakes were too big.”
~ Ian Hunter, WPCT
As the returns began to suffer, investors started to ask for their money back, forcing the fund to sell the most liquid assets to meet the demand. Once that had dried up, a fundamental flaw in the whole asset management sector was exposed: funds offering daily withdrawals, despite not holding anywhere near the amount of cash or cash equivalent instruments that might be needed to meet that obligation.
Finally, a noble aim of Mr Woodford’s — full transparency on his holdings — opened an avenue for short sellers to take advantage. They could see where the pressure points were and were able to drive down the prices of investments they knew he would have to sell. This exacerbated the problems facing the fund.
What can be learnt?
Asset managers across the board need to learn from this.
Firstly, the mismatch in liquidity is particularly worrying. More funds are being directed towards real-estate, emerging markets, unlisted stocks, and long term bonds in a chase for better returns as the era of ultra-low interest rates continues. It would not take much for another Woodford fund situation to occur, leaving investors high and dry. Investors will be looking at the funds they are exposed to and asking these questions in the next few months, and asset managers must have the answer.
Secondly, proper risk management within governance structures remains important. There is an overarching question that boards, management teams, and regulators must focus on: what are the risks that could sink the fund? Assessing these accurately is crucial. This requires data to be collated and presented in a more useful and insightful way than currently exists. Boards must take the lead in asking probing questions to force management to consider existential risks and put compliance teams and risk committees in place to oversee them.
Both of these issues rely on the right information being given to the right people at the right time. Governance and controls should never be sidelined, despite the temptation to rely on star individuals leading without oversight.
As Gerry Grimstone, until recently Chairman of Standard Life Aberdeen, said:
“Never buy a fund named after someone.”
~ Gerry Grimstone, former Chairman of Standard Life Aberdeen