On 3 June 2019, Neil Woodford, one of the most high-profile stock pickers in the UK, was forced to suspend the trading of his flagship fund as rising numbers of investors asked for their money back that had jeopardised the ability of the manager to run the fund effectively. The value of Woodford Equity Income fell from around GBP 10 billion two years ago to just GBP 3.7 billion today, because of a spate of poor performance that had driven his loyal supporters away. Mr Woodford at the time said that trading of his fund was suspended to allow time for him to reposition his portfolio and protect investors, after investors had been abandoning the manager, following a continued period of weak performance. It had been shrinking by an average of GBP 10 million every business day for the last 23 months and in May, the long-term focused fund suffered a 23rd consecutive month of withdrawal. During the month, as Woodford Equity Income was down by 8.3 per cent, it underperformed the FTSE All-Share index, which fell by 2.5 per cent.
Mr Woodford’s star status was secured after 25 years of market-beating returns during his stint with Invesco Perpetual, one of the largest investment managers in the UK, but his performance, since he went alone five years ago has been dramatic. With corporate headquarters in Oxford, unlike London, the fund performed well in its first two years of operations but took a nosedive from thereon. In its first year, the returns of 18 per cent on investors’ money were reported, compared with an average rise of only 2 per cent on the London Stock Exchange at the time, but he had warned the investors that it was far too early to conclude that the fund’s strategy had worked, and indeed he was right in predicting this at least. However, after hitting its peak, the fund has struggled in the last couple of years.
The company had to resort to devising more creative ways to rebalance his portfolio, including listing some stakes in companies, as the regulatory imposed limit of investing 10 per cent in unlisted stocks was proving problematic for Mr Woodford. Moreover, investors redemption had made his task of adhering to that limit made difficult as these illiquid assets are harder to sell than listed equities. The decision to suspend trading was triggered by the decision by Kent County Council, which had backed the fund manager for over a decade but wanted to withdraw its GBP 263 million investment. However, they were unable to do so as trading was halted before they could withdraw. Some fund experts have said the suspension could last as long as three months as Mr Woodford gets on with the task of investing in publicly listed shares that can be traded more easily by selling some of his illiquid private holdings.
Since venturing out to start his own fund, the investment focus of Neil Woodford has shifted toward unlisted stocks in companies with unproven technologies or pharmaceutical products, at times making full use of the 10pc allocation he is allowed to have under fund management regulations. Since Mr Woodford has held a large proportion of the portfolio in unquoted stocks, he had been forced to quickly sell off assets to meet redemptions after people decided to leave the fund and sell their investments following years of poor performance. The illiquidity issue faced by the fund was exacerbated because more listed shares had to be sold off to keep up as investors left as so much of the fund was invested in illiquid assets such as private companies. To prevent the problem from snowballing, the fund was forced to close its doors.
The troubled fund also has credit facilities, including a £150 million loan lent by Chicago-based bank, Northern Trust. The loans were disclosed in fund documents and are backed mainly by private shares in risky young companies the fund invested in. According to Britain’s Association of Investment Companies, no other fund in the country that invests in risky, early-stage companies uses any leverage at all, and so the loan by the bank to the Woodford Patient Capital Trust was rather unusual. While Woodford Patient Capital Trust runs with leverage close to its limit of 20 per cent net asset value, the trust sector in the country in general has average leverage of 9 per cent of net asset value.
Andrew Bailey, chief executive of the Financial Conduct Authority (FCA), said on Tuesday that the meltdown of the flagship equity fund was fuelled by flawed rules of the European Union that may need to be discarded after Brexit. On 18 June 2019, the UK financial watchdog had opened a formal investigation into the freezing of the fund and had notified Woodford Investment Management of an enforcement investigation, which could result in bans and fines if any wrongdoing is found. It also admitted that the star stock picker twice breached a key liquidity limit, which limited a 10 per cent regulatory cap on unlisted securities.
Now, Mr Bailey denied the episode stemmed from supervisory failures, as questions are being asked over why regulators did not intervene. He said that the fund took full advantage of flawed European Union rules before withdrawals had to be halted and it could have been better policed if the regulations had left more scope to crack down on behaviour that complied with the rules technically but acted on the wrong side of the spirit of them.
According to the regulator, by exploiting gaps in highly detailed regulations known as UCITS, the fund managers were able to engage in regulatory arbitrage, a term used in London to describe firms making use of legal loopholes. Undertakings for collective investment in transferable securities (UCITS) allows a maximum of 10 per cent of assets in unquoted and illiquid assets, with the rest must be listed on an approved stock exchange and are designed to ensure funds are highly liquid and to protect investors from unnecessary risk. The regulator told the Commons Treasury select committee that the fund had not intimated the FCA about the same. He further said that the whole scandal was more a failure of rules as the fund was using the rules to the full, but not in the right spirit. He added that that is a feature of much of the system of the European Union and demonstrated the problem that with an excessively rules-based system, instead of being based on principals.
In an attempt to keep within the European Union rules, the troubled fund got its previously unlisted assets a listing on Guernsey’s stock exchange, helping them to not breach the 10 per cent limit. Andrew Bailey stated that out of a cohort of 3,000, the Woodford Equity Income fund was just one of two in the country that had breached the cap. A formal investigation into the listing of some of the assets on a stock exchange in Guernsey and the events surrounding the suspension has been opened by the financial regulator.
While Mr Woodford had long insisted publicly that the suspended fund had not breached the limit, in a letter to the Treasury select committee, which was published on 18 June 2019, Mr Bailey revealed that the regulatory cap on unlisted securities in February and March last year had been exceeded by Mr Woodford. The fund manager had said that the two inadvertent intra-month passive breaches were resolved before month-end and the fund always provided month-end data for investors and at no time was there a month-end passive breach. However, Mr Bailey told the committee on Tuesday that this breach had led to enhanced monitoring by the FCA, calling it symptomatic of the fact that they were sailing close to the wind.
The Financial Conduct Authority has come under intense criticism after the run on Mr Woodford’s business, and serious questions are being raised over whether it could have done more to prevent the fund’s meltdown as the regulator had concerns for months about increasingly dire liquidity position of the fund. While the FCA said that it had previously been unaware of the decision to list certain assets on the Guernsey-based International Stock Exchange (TISE), the questioned exchange house said it made several attempts to contact the financial regulator back in April 2019 but received no initial response.
After suspending trading of his fund, Mr Woodford admitted that there had been company specific issues within the portfolio and apologised for putting the clients in the situation. He added that he had been the victim of a largely valuation-insensitive market and defended his portfolio, which he said was undervalued, with every asset in the portfolio commanding a fundamental value that significantly exceeds its share price. He further said that he would turn the fund around, and investors would see a much more liquid portfolio when the fund reopens.