If you’ve been reading the news lately, you’ll have found it hard to miss the stories about Neil Woodford’s investment firm and one of its funds.
So, what happened?
Neil Woodford is what you call a superstar in the investing world. At one point, he was running a £25 billion fund and was regarded as the hottest UK fund manager, a status backed up by a multidecade run of stellar performance. In 2014, he decided to open up his own fund management company and this is where things started to get rocky for the star fund manager.
Woodford’s flagship fund, the LF Woodford Equity Income Fund, was worth £10.2 billion in May 2017 – its highest value. Fast forward to today and the story has dramatically changed. The fund is now worth around £3.8 billion and all trading has been suspended until further notice, meaning investors can’t sell their holdings in the fund until Woodford says so.
Woodford is an active fund manager and investors pay him to outperform the wider financial market. But he has recently made poor investments into companies that have underperformed the wider market, affecting his performance. These companies include Provident Financial and Purple Bricks.
The poor performance compared to his peers and the wider market led to a flood of withdrawals. Although disappointing for both Woodford and his customers, this created a problem due to the fund’s holding in shares of private companies.
Shares of private companies are defined as “illiquid assets”. What does it mean, you ask? Unlike public companies, private companies aren’t listed on a public financial market where people have access to buy and sell investments daily, and as a result, they’re more difficult to sell.
As the flow of withdrawals from the fund increased so did the percentage of illiquid assets held. Suddenly the realisation that the fund is becoming difficult to sell created panic amongst investors and a stampede for the exit followed.
This forced Woodford to suspend trading in his flagship, LF Woodford Equity Income Fund.
Although investors may want their money back immediately it isn’t that simple and may take months to sell the necessary private shares required to cover the withdrawals requested.
This may sound alarming, but the suspension is likely a good thing for investors in the LF Woodford Equity Income Fund. It’ll give the manager more time to get a better price for those investments he needs to sell.
Investors must remember they haven’t lost their money; they just can’t access it right now. There’s a big difference between the two.
Do we invest in Woodford funds or similar ones?
As the story broke, we’ve had many customers contact Wealthify asking if we own any Woodford funds in our investment plans. The answer is no. Our inhouse fund selection process at Wealthify removes funds like Woodfords’ from possible inclusion in our investment plans.
What stops funds like the LF Woodford Equity Income Fund from being part of your Wealthify Plan?
It’s easy to say with hindsight that you’d never have invested in his fund, but Woodford was a rock star in the fund management industry. At the time you would’ve been crazy shying away from the fund manager who seemed to have the Midas touch!
Luckily for Wealthify customers, our fund selection process prevents funds like Woodford’s from being a part of your Investment Plan.
The funds used in our Original Investment Plans have an average total cost less than 0.40%. The LF Woodford Equity Income Fund costs 1% per annum. It would be too expensive to be included. We deliberately focus on keeping costs low, meaning we tend to avoid so-called star managers.
Accessibility also known as liquidity in the investment industry is key when investments are considered for inclusion into Wealthify investment plans. With the option at Wealthify for customers to deposit and withdraw on a daily basis, we must be able to sell our customers’ investments when requested. Funds that hold illiquid assets such as shares in private companies or those that are not listed on a recognised stock exchange, are excluded from selection because they would prevent the accessibility our customers require.
Diversification is a process that can help investors mitigate risk. How does it work, you ask? Your money is simply spread across many different investment types and regions, that way poorly performing investments can be offset by others that are doing well. Diversification wasn’t a priority for the LF Woodford Equity Income Fund. In fact, the fund favoured larger positions in a smaller number of holdings, the opposite of diversification. Put simply, people’s money was invested in just a few companies. Some investors applaud these types of decisions and define this style of investing as “brave or “heroic” - when things are going well. However, when you’re not diversified, and you experience poor performance of one or two large holdings it has a big impact on your overall return. At Wealthify, we prefer diversification.
These are three key hurdles that would prevent the LF Woodford Equity Income fund from appearing on our investment team’s radar. We wouldn’t invest in funds that fail at one of the above hurdles – this particular fund failed all three.
How do investors avoid making the same mistake twice?
There are three ways to help investors avoid making a similar mistake.
First and foremost, there should be a re-examination of the regulation that better governs the investment products sold to retail customers. In this case, most retail customers were likely unaware of the possibility they couldn’t get their money out when they wanted to. The LF Woodford Equity Income Fund had allowed buying and selling daily, however the investments held in the fund cannot all be bought and sold daily, creating a mismatch between the investment vehicle, the underlying investments used like private shares, and customer expectations.
This problem also occurred after the Brexit vote where property funds that offered daily access to investors suspended trading of their funds, as they could not physically sell the properties quick enough to match the investor withdrawals being requested. This is one of the key reasons that the fund we use to gain access to property is invested in Real Estate Investment Trusts (REITs) that are essentially shares of the companies that own property.
Investors should look at their investment plans and make sure they are suitably diversified. Although any large loss is painful individually, if the fund forms a small part of a larger investment pot, the negative impact will be much smaller.
Do your homework
If you’re an investor that wants to pick your own funds or stocks make sure you do your own homework and due diligence. The easy option is to go with the flow and pick the most popular funds or managers. Take a step back and develop a process that helps remove human bias, it is also important to consider the motivations of any research providers, or platforms.
Investors that don’t have the time or want to do it themselves have plenty of options where companies will build, manage and sometime advise on your investments. There are traditional and online investment managers that can do the hard work for you.
What has happened to Neil Woodford and investors in the LF Woodford Equity Income Fund is not a victory for anyone. It is an example of how things can go wrong, and hopefully, the rest of the investment management industry and investors will learn from the mistakes of others.
Investors who remain stuck in the fund should also remember, as mentioned earlier, that your investments have not been lost, you simply can’t access them right now. Hopefully it works out for everyone involved and some lessons have been learnt.
Please remember the value of your investments can go down as well as up, and you could get back less than invested.
Investing is for everyone.
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