Liquidity Mismatch Engulfs Famed Managed Fund

The LF Woodford Equity Income Fund Saga - Part 1

Countdown to Crisis: Timespan 2 June 2014 to 3 June 2019

A prominent British retail managed fund has fallen into strife, in the process triggering serious questions about the way in which such financial products should be managed and regulated.  The case of the LF Woodford Equity Income Fund (WEIF) has raised concerns about why such a closely monitored and apparently compliant managed fund was abruptly forced to suspend investor trading in its shares due to an asset liquidity crisis.  In the first section of two articles, we examine how WEIF’s crisis was brought about by the investment manager’s decisions.  In the second part, we will consider issues arising around the supervision of the fund by related parties and the regulator.  

WEIF was launched in tandem with the Woodford Equity Income Feeder Fund (WEIFF) as a British open-ended UCITS fund on 2 June 2014. Billed as the “original Woodford fund”, WEIF is pitched at UK-based investors.  The related and dependent WEIFF is designed to channel offshore investor funds into WEIF.  Key parties involved in WEIF are Link Fund Solutions Limited (Link) acting as the authorized corporate director, which is a complex, omnibus role that in New Zealand’s financial markets environment would translate into a combination of fund promoter, manager, supervisor, custodian, middle-and back office, administrator, and registry.  Another party is Northern Trust Global Services SE (Northern Trust), which acts as the depositary in holding WEIF’s assets and exercises independent governance and oversight of some of the functions of Link such as fund trading suspensions and listing of shares on stock markets.  Link appointed Woodford Asset Management Limited (WIM) as the investment manager of WEIF.  Link and not WIM is accountable as the fund operator to the regulator, the City of London’s Financial Conduct Authority (FCA), and is responsible for ensuring that WIM adheres to WEIF’s investment mandate.

The LF Woodford Equity Income Fund in Summary*

*Sources https://woodfordfunds.com/funds/weif/fund-facts/ and   https://woodfordfunds.com/funds/compared/

** 10% cap under European Union Undertakings for the collective investment in transferable securities (UCITS) - Directive rules.

A Star Investment Portfolio Manager

WEIF’s portfolio manager, Neil Woodford, has long been celebrated as an investor with a Midas touch.  From 1988 until he set up his own funds management shop in 2014, Mr Woodford had been hugely successful as a contrarian value manager of some 33 billion pounds’ worth of funds under management at Invesco Perpetual.  Probably the nearest a fund manager has got to becoming a household name in Britain, in 2013 Mr Woodford was appointed a Commander of the Order of the British Empire (CBE) for services to the economy, and in 2016 awarded an honorary fellowship by the London Business School.  He has been so powerful and respected in capital markets that his public opinions have influenced corporate events.

Mr Woodford was described in a BBC article from June, 2015, as “the man who can’t stop making money” and “Britain's very own Warren Buffett”.  The article enthusiastically celebrated an 18% initial year return on the flagship WEIF since inception versus just 2% return from an average London Stock Exchange-listed share over the same time period. Mr Woodford was quoted as saying, "I would suggest that a healthy balance between arrogance and humility is helpful," and "It's far too early to conclude that the fund's strategy has worked". These words have come back to haunt him.

Mr Woodford took a contrarian view of Brexit, believing unlike many others that shares in companies exposed to the British domestic economy would benefit greatly from the departure of the United Kingdom from the European Union.  He was also attracted to listed smaller-capitalisation stocks and unlisted new companies, taking substantial stakes in them even though these investments offered less share market liquidity than listed larger-capitalisation firms. 

The combination of these views would prove to be the downfall of WEIF as Mr Woodford invested in accordance with them despite the fact that the fund offered investors daily transactional liquidity.  The prospect of a liquidity mismatch lurked within WEIF’s portfolio should the fund suffer a prolonged and severe run of withdrawals.  In particular, WIEF could run into trouble because of the European Union’s UCITS Directive rule that a UCITS fund cannot have more than 10% of its capital invested in unquoted (ie., unlisted) securities. In Britain, that rule is enforced by the FCA and encoded in its Collective Investment Schemes (COLL) sourcebook.

From Hubris to Humiliation

In March 2017, funds under management in WEIF peaked out at 10.2 billion pounds.  Yet by early December 2017, Mr Woodford was justifying poor performance of the fund in a Financial Times article, wherein he was called, “Britain’s best-known fund manager” and described as being responsible for some 15.5 billion pounds of funds under management.  At that stage, WEIF had dropped to 8.3 billion pounds in size due largely to sustained investor withdrawals driven by questions over unsatisfactory investment returns.  Performance-wise, the flagship fund was then down year-to-date by -1.4% versus its benchmark, the FTSE All-Share Index, being up nearly 10%. The closed-ended Woodford Patient Capital Trust (WPCT, listed in the London Stock Exchange’s FTSE 250 on 21 April 2015), which had been created to hold early-stage, unlisted disruptive technology and biotechnology companies, had shed a 15% premium to net asset value to trade at a -5.4% discount. 

In the Financial Times article, Mr Woodford defiantly rejected criticism of WEIF’s performance over the previous 18 months and urged his investors to stick with him nonetheless.  “It’s an incredibly uncomfortable place to be, where I am now,” he was quoted as saying.  “It is the most uncomfortable position I have been in during my career.  But I believe I’m absolutely right.  I don’t know when I’m going to be proved right, but I’m utterly convinced that I am right, as I have been right before.” Mr Woodford went on to say, “You have to have a sufficiently strong arrogant gene to back your judgement, back your conviction.  If you didn’t, you would end up with a portfolio that looks very much like the index.  But equally, you must have the humility to accept that you will get things wrong.”

In May 2018, on the brink of the fourth anniversary of WEIF’s launch, the website Fund Expert rated the fund a sell for underperformance.  WEIF’s woes mounted over 2019 with a steady string of bad news stories.  In February, WEIF was added to the “Spot the Dog” list of Bestinvest.  In March 2019, Mr Woodford again came out vigorously in his own self defence.  Fund rater Morningstar demoted WEIF from bronze to neutral in May, having stripped the fund of a silver rating the year before.   A Woodford spokesman was quoted as saying, “The fund is managed so it can stay within its agreed liquidity limits and these are set conservatively so the fund can comfortably meet any redemptions as they fall due.”

Fast forward to early June 2019. When WEIF’s shock trading suspension hit, the news was all over British financial headlines.  At that stage WEIF had fallen 34% over the past two years, with 23 consecutive months of net withdrawals.  Investor funds were being pulled out at the rate of 10 million pounds per day.  Funds under management had fallen 63% from peak value to 3.77 billion pounds. 

As more and more investors redeemed their funds, piling selling pressure and a liquidity squeeze on investment manager WIM, the ratio of liquid assets to illiquid assets in WEIF deteriorated.  Remaining investors were faced with a panic race for the exits, devil take the hindmost, which threatened to give rise to inequities between them. The straw that broke the camel’s back came when the trustees of the Kent County Council pension fund, fearful at the ongoing redemption drain, vainly requested that WEIF redeem their 263 million pound holding in it.  Their attempted withdrawal coincided with WEIF having no cash in hand and an overdraft facility that required immediate repayment. At that point, the troubled Woodford fund was “gated” indefinitely by Link and Northern Trust to avoid fire selling of assets and greater resulting illiquidity in the remainder of its portfolio.

The Axe Falls

Five years and a day after its fanfared launch, WEIF came under intense media scrutiny when on 3 June 2019 its retail fund manager, Link, was obliged to announce suspension of investor dealing in the fund’s shares “with immediate effect and until further notice” due to fund liquidity problems.  In a knock on effect, share trading was also suspended for WEIFF. The other two Woodford funds, the open-ended LF Woodford Income Focus Fund (WIFF, launched 20 March 2017) and WPCT were not subject to trading suspensions.  However, since news of the WEIF/WEIFF suspension broke, WIFF has reportedly experienced increasing withdrawals while WPCT has suffered heavy share price falls and attracted predatory attention from hedge funds.

The suspension notice for WEIF stated, “…it is in the best interests of all investors in the Fund to suspend the issue, cancellation, sale, redemption and transfer of shares in the Fund. Following an increased level of redemptions, this period of suspension is intended to protect the investors in the fund by allowing Woodford, as previously communicated to investors, time to reposition the element of the fund’s portfolio invested in unquoted and less liquid stocks, in to more liquid investments.” 

Investors who did not get out in time face an uncertain wait, not knowing when they will get their money back or how much they will receive.  The portfolio reconstruction that Link announced for WEIF into more liquid assets perhaps optimistically assumes that the fund has any future as a going concern once investors can quit it again en masse.

In Part 2 we consider the response of regulators and other parties involved to the trading suspension of WEIF.