When Neil Woodford, one of the City’s star fund managers, commissioned a study in early 2016 about the economic impact of Brexit, little did he realise he might become a footnote to the story.
Woodford’s equity income fund was shuttered in June, as spooked investors rushed for the door. Many of Britain’s savers, who thought they were prudently planning for retirement, a wedding or a nest egg, are now waiting nervously for the fund to reopen in December.
So far, the collapse of his investment fund has either been told as a tale of hubris, the case of a stellar financial performer who succumbed to his own hype. Or it’s explained as a liquidity miscalculation, a technical mismatch of money coming in and money going out, as Woodford made long-term bets on unquoted companies while investors could get their cash out as and when they wanted. Or it’s pitched as another failure of governance and regulation, where the board was crammed with yes-men and the financial regulator has done too little too late.
Last week, Tortoise held a ThinkIn on what we can learn from Neil Woodford, during which people from across all corners of the City helped us to understand what’s really happened. And, yes, all of those elements – personality, marketing, long vs short-term, oversight – have played their part.
But the most interesting finding was that Woodford is Britain’s biggest corporate casualty of Brexit yet. As we were told by one person who has followed the collapse of the Woodford funds closely, it wouldn’t have happened if the Government had got its Brexit deal through in the spring.
Here’s why. Woodford had bet big on Brexit: he was expecting a resurgence in the fortunes of UK-facing companies once the path to leaving the EU became clear. He told savers that companies generating their revenues in the UK are cheaper than he’s seen them in his entire 30-year career.
But Parliament kept blocking a Brexit deal and those UK-facing FTSE companies kept sinking in value.
The way his fund worked was that the majority of the investments were in such quoted equities, i.e. companies on the stock market. In addition, Woodford had sprinkled his funds with some unquoted companies – including biotechnology firms from Oxford University, near his base. As Woodford sold shares in his publicly quoted investments to pay savers who wanted their money back, his unquoted holdings came to represent a bigger part of the fund, breaching their regulatory limits.
Under the rules of an open equity fund, only 10 per cent can be in those unquoted stocks. And as the value of Woodford’s investments in quoted British companies fell, the value of the unquoted stocks rose as a proportion of the overall fund, breaching the limit and rising to 18 per cent of the fund. A spiral had begun: people began to see the scale of the illiquid investments he held, worried and started to pull their money out.
Initially, investors had flocked to Woodford’s fund. When it was set up in 2014 it took in £1.4bn in its first two weeks, and was worth a whopping £10.2bn at its peak. But it shrunk by two-thirds between May 2017 and its closure in June this year to £3.7bn, following months of outflows and poor performance.
Savers had been seduced by Woodford’s reputation built up over 25 years as a stellar manager of money. And in the first year they were proved right with an 18 per cent return as the fund outshone rivals and the market as a whole (which was up only 2 per cent). But, after that, its performance unravelled and, according to FE Analytics, between launch and suspension the fund made a total return of only 0.36 per cent.
Woodford’s Brexit bet had seen him shift from the style he’d become famous for during his previous role at Invesco Perpetual. From spotting value in large companies that paid solid dividends, he moved to investing in small- to medium-sized organisations with a UK focus. He had concluded in early 2016 that Brexit would have little or no economic impact on the UK economy. He believed that a lot of the discussion around Brexit was “bogus”, saying it was a political decision not an economic one. His hunch was that he’d found another turning point for UK companies that were being undervalued by the market because of Brexit, while bigger, more global companies were benefiting from a fall in the pound.
Ironically enough, it was the EU rules that caused his problem. The EU regulations require public investment funds only keep a certain percentage in companies that are not publicly listed on a stock exchange. In order to get around this rule, Woodford listed some of his holdings on the Guernsey stock market – a move that was not illegal but certainly appeared to be against the spirit of the law. The regulator is now investigating that decision.
Over the years, Woodford had done extremely well for his clients. Over a quarter of a century at Invesco, he turned an initial investment of £10,000 into £250,000. He is credited with taking unpopular decisions that go against consensus thinking – for example, he sat out the boom in technology stocks in the late-1990s dotcom bubble and avoided banks years before the 2008 financial crisis.
“Let’s not forget, Neil was a genius,” Tony Langham, co-founder and chief executive of Lansons, told the ThinkIn. “This is a terrible tragedy. Neil did all of the things we ask fund managers to do.”
When he set out on his own, Woodford was heavily marketed. Funds were channelled via online platform Hargreaves Lansdown where his Brexit strategy fell on sympathetic ears – Peter Hargreaves, one of the firm’s founders, donated to the Leave campaign.
Best-buy tables listed by online investment platforms are not always what they seem. These lists are intended to help DIY investors choose from the multitude of funds on offer. Hargreaves Lansdown championed the Woodford fund and listed it on its Wealth 50 top picks even as it dropped in value.
Savers could be forgiven for thinking that these best buys are the finest performers on offer in the market, but the relationship can be more complex than that. Hargreaves Lansdown negotiated a discount of 0.10 percentage points in the fees for savers putting money into their best buys. Hargreaves has argued this is for the benefit of investors, but it does muddy the decision as to whether a fund would be included on the list if it did not offer the reduction and has led to accusations that managers were “buying” their way on to the lists.
The public places an enormous amount of faith in these lists, hoping that they are picking out winners and they drive large investment flows. Hargreaves Lansdown alone channelled some 300,000 customers towards Neil Woodford.
“People who invested through Hargreaves Lansdown would get a discount. Now, in the insurance world we call this ‘favoured nation’ and [in that industry] it’s illegal,” Rebecca Jones, editor of Good With Money, told the ThinkIn.
Neither are these platforms as heavily regulated as savers might imagine them to be; the regulator looked into it a few years ago but backed off. The FCA is now reviewing the platforms and the service they provide again, to ensure that the lists really are impartial.
Investment requires a long-term approach and Woodford’s strategy may pay off some day. But the debacle highlights important problems for the savings industry. Individuals tend to have much shorter time horizons than the managers to whom they are entrusting their money. They place their bets in markets they don’t always fully understand, and do not have the wealth or nerve to stick with them through the ups and downs.
As Mark Carney, the Governor of the Bank of England, has pointed out, these products are not bank accounts and should not promise ready access to cash. Investors cannot always rely on intervention by the financial regulator, which tends to decide after the event whether there has been misconduct – often too late for those who have lost their stakes.
The issue yet again raises a number of questions about the set-up and governance of the savings industry and whether it is fit for purpose. Repeated financial scandals, such as PPI mis-selling and the Equitable Life pensions collapse, have rocked the public’s confidence in finance. At a time when we all need to be saving more for a longer retirement, the industry appears to have let individuals down.
Woodford has said that investment requires an arrogance gene to stick with your decisions when your style may be out of favour. Savers are not so patient – comments under the YouTube video of him explaining his decision to close the fund accuse him of incompetence and greed.
In 2014, the same year he left Invesco to set up his own company, the financial regulator fined Invesco £18.6m for some breaches to the Woodford fund’s stated investment style from 2008 to 2012. This should have been an early warning sign for his fans. The FCA cited breaches of investment levels at two of Woodford’s funds – among others at Invesco – and the introduction of leverage without telling investors. But the fine was tiny compared to the billions under investment and it did little to dent Woodford’s self-confidence.
There are also question-marks over the role of the board at Woodford’s fund. At Invesco, he was subject to the checks and balances of a large organisation where deviations from his management style might get spotted. But, on his own, his board members might be more accommodating.
As Tony Langham said at the ThinkIn: “Those board directors had a chance to do something and they didn’t do it because groupthink took over.”
It is the governance of the industry as a whole, however, that is in the spotlight. The Financial Conduct Authority was privy to meetings of the Woodford fund in the run-up to its suspension and arguably should have intervened sooner. It has now launched an investigation into the closure of the fund, but critics have said it was asleep at the wheel.
The media shares some of the responsibility for hyping up managers such as Woodford, only to slate them as soon as their performance dips. The regulation of commissions in 2013 has meant that it is often prohibitive for small-scale savers to access financial advice, which has seen them turn to the media and online sites to research their investment choices. Fund management groups are keen to sponsor coverage and offer inducements to reporters to feature their funds as a way to encourage buyers. What appears to readers to be unbiased coverage has often been carefully massaged at schmoozefests between insiders.
The regulator has come in for a lot of criticism over its handling of the Woodford debacle. But it should be noted that the FCA’s emphasis on the spirit of the law, rather than the strict letter of it, can be a good thing. As Toby Nangle of Threadneedle Asset Management explains, it allows a certain degree of flexibility and also “ensure(s) that no firm is able to easily evade its regulatory judgements by reference to some legalistic loophole”.
Fund management firms have a duty of care towards their clients, but it is harder to serve thousands of retail savers, all of whom need to be treated fairly, than large institutional customers with many millions to invest. While firms say it is expensive to serve retail savers, the industry is still extremely profitable.
In a recent study, the FCA attacked investment firms for their large profit margins – of around 35 per cent (twice as high as that enjoyed by many big companies). Money has flooded into the fund management industry since the financial crisis, as banks have been subject to tight regulation and interest rates are low. Savers are chasing returns where they are not always easy to come by. They can be tempted to take more risks than they should.
Woodford was an unusual investor for consistently outperforming the market, but not many managers carry that off. A trope of the personal finance pages is to pitch a cat or another animal against seasoned stock-pickers, only to show the cat does best, and it doesn’t charge.
Over the longer-term many savers would be better off putting their money into low-cost passive or tracker funds, but you need the stomach to ride out the market’s highs and lows. And many small savers just do not want to see their nest eggs dwindle.
These pressures are higher in Britain than in many other countries. The British finance industry stands out for having pushed much of the responsibility for funding retirement on to individuals. State pensions in countries such as Germany and France are much higher than in the UK.
Financial regulation is always fighting yesterday’s battles while dangers lurk in previously over-looked areas. Whether the next systemic financial crisis will fall in the retail fund management sector remains to be seen, but it is an industry that has repeatedly failed to serve its customers well.
For now, Woodford’s investors do not know when or if they will see their money again.
Tony Langham, co-founder and chief executive of Lansons, said that he feared the worst could be yet to come. “People want their money…. When I started working in the industry in the 1980s, the industry would have all got together and said: ‘You’re finished mate, you’ve got to back this company into a bigger pool of assets for the good of all of us.’”
If Brexit eventually has an orderly outcome, Woodford’s bets are likely to pay off. But many savers may not be able to wait that long.