While it may well be clear to the UK fund industry and its regulator what went wrong with the Woodford Equity Income Fund, to date, very little has been proposed to correct matters and prevent a repeat, writes Jan Wagner…
It’s not an exaggeration to say the blow-up of the Woodford Equity Income Fund (WEIF) was one of biggest debacles in the UK fund industry. There were several reasons for the WEIF’s problems, the main one being a failure of oversight.
But what really happened and what has been learned from the fiasco? Launched in 2014 by Neil Woodford, who had an excellent track record at Invesco, the WEIF’s aim was to provide steady income for its investors. According to the prospectus, this was to be largely achieved by investing in listed UK companies.
“It was marketed strongly by intermediaries as an investment that would be ideal for widows and orphans,” says Shiv Taneja, CEO of the Fund Boards Council, which advocates strong fund governance, and between 2015 and 2017, the WEIF’s strategy worked just fine as it outperformed the benchmark FTSE All Share Index.
As 2018 began, Woodford changed the fund’s strategy by taking large and ultimately unsuccessful bets on unlisted (and illiquid) start-ups. By February 2018, the WEIF looked more like a daring private equity fund than a product that was supposed to play it safe. The Financial Conduct Authority (FCA) ordered Woodford to cut his unlisted holdings, as the fund violated a UCITS rule capping such exposure at ten per cent which is aimed at ensuring liquidity in an open-ended fund.
Why Link Asset Services, which as the authorised corporate director (ACD) was supposed to supervise the fund, allowed Woodford to violate the rule is still an open question. Richard Evans, Questor Editor at the Daily Telegraph, thinks it was in part due to Woodford’s status as a star manager and boss of Woodford Investment Management. “Had he been part of an organisation whose staff could challenge the fund manager’s decisions, much of the damage could have been avoided,” says Evans. That view may be right, but its does not fully explain why Link allowed Woodford to go rogue.
Woodford got back into compliance, but the damage from his strategy shift was already done. In 2018, the WEIF lost nearly 17 per cent of its value and suffered huge outflows as investors lost confidence. When the WEIF froze redemptions in June 2019 due to scant liquidity, its assets had dwindled to GBP3.7 billion from GBP10 billion in 2017. The fund’s fate was sealed in mid-October when Link fired Woodford and decided to wind up the fund. Now, unlucky investors locked into the WEIF stand to lose 30 to 40 per cent of their capital.
One might assume the UK government would take steps to prevent a debacle like the WEIF from recurring. Indeed, Bank of England Governor Mark Carney told the UK parliament in late June that funds like the WEIF “were built on a lie.” He called for new rules. Another reasonable assumption would be for the industry to acknowledge that a reform of UCITS funds in the UK is in order and support such a reform.
As of yet, however, very little has been proposed to correct matters, for example strengthening governance at UCITS funds. FCA CEO Andrew Bailey says he’s waiting “for the dust to settle” before considering a review of the ACD system. Interestingly, the FCA has actually implemented some new governance rules, but these apply to closed-end funds. The rules include the mandatory appointment of two independent directors to fund boards and a requirement that managers disclose whether they are using benchmarks or another performance measure. Bailey has also been quoted in the UK press as saying he favours keeping institutional investors separate from retail investors in open-ended funds. This would presumably shield retail investors from abrupt outflows, but it doesn’t address the liquidity issue that led to the WEIF’s downfall.
For now at least, the Investment Association (IA), the lobby for UK open-ended fund providers, is not advocating for much change. Chris Cummings, CEO of the IA, has told the Financial Times that the UCITS structure “is fundamentally fit for the purpose” of ensuring sufficient liquidity for open-ended funds and, hence, protecting investors. According to him, the only thing that could be improved is the “toolkit for liquidity management” at the funds. Regarding that point, the IA has proposed a “long-term asset fund” (LTAF) that would be targeted to investors looking for opportunities among illiquid assets. Depending on the fund’s liquidity position, the LTAF’s manager would decide the dealing frequency and lock-up periods for investors.
The IA’s idea for a LTAF sounds reasonable. But the central issue, namely the danger that the WEIF fiasco could be repeated, has yet to be addressed head on by the regulator or the fund industry. That could soon change, if Bailey makes good on his promise to review the ACD system. Says Shiv: “I would support a strengthening the current ACD system. In the case of Woodford, there was clearly a failure of governance at the fund level.”