The Woodford fund suspension and some differences between active and passive funds

Posted by Andrew Gordon on October 15
gate

Article originally written on Thursday 11th July 2019.

Update on 15th October 2019: The fund is to be shutdown with the winding-up expected to begin in January 2020.

As you may have heard in the news, in the last few months one of Britain’s most well-known fund managers, Neil Woodford, was forced to suspend trading in his main fund, the Woodford Equity Income fund. This means that there will be no inflows or outflows allowed in the fund until the suspension is lifted. People who invested in the fund still own their shares of the fund, which still have value. The fund is still actively managed on behalf of investors as normal, but you aren’t allowed to sell or buy any more shares in the fund while it is suspended.

Why did he suspend the fund?

After a successful 25-year career at Invesco Perpetual Neil Woodford decided in 2013 that he would quit and start his own firm called Woodford Investment Management. He launched the Woodford Equity Income fund in June 2014. 

The Woodford Equity Income fund consisted mainly of large UK companies that are listed on the London Stock Exchange. These shares normally have a lot of liquidity and so are easy to buy and sell.  However, the fund also held shares in smaller companies that are unlisted which means they are harder to buy and sell.

The fund had good performance for the first three years. In June 2017 the fund was up nearly 39% and this was 12% higher than its benchmark, the FTSE All Share Index. Unfortunately, the good performance did not last, and the fund lost nearly all these gains by the end of May 2019.

Due to this recent bad performance the fund seen large levels of redemptions. A redemption is when someone wants to sell their shares of the fund and have cash returned to them. The fund size was reported to have been approximate £10.2 billion in size March 2017 and at the end of May 2019 was approximately £3.71 billion.

According to the Financial Times [1] to raise the cash to meet these redemptions in 2017 and 2018, Mr Woodford was forced to sell some of the easily traded large companies. This meant that the smaller unlisted companies became a larger proportion of the fund. There is a 10 percent limit on investing in these small unlisted companies for Woodford’s type of fund and the fund was getting close to hitting this limit. To not hit this limit Mr Woodford reportedly switched £73m of this unquoted stock into an investment trust that he also ran called Patient Capital Trust. He also listed stakes in some private companies on the Guernsey Stock Exchange which is less regulated than the London stock exchange.

The fund was seeing a large amount of redemptions in May 2019 and on 31st May 2019 the Kent County Council asked to redeem their £263m of the fund. It was at this point that Mr Woodford decided to suspend the fund on the 3rd June 2019.

In a video that Mr Woodford published on his website that can be found here he explains that it was a difficult decision to make but the suspension is necessary to protect investors interests. He explains that if the fund wasn’t suspended and they had to keep selling parts of the portfolio to raise the cash for redemptions, the parts of the portfolio sold would be sold for prices that were disadvantageous for investors.

He states that the suspension provides them with the time and space to reduce the fund’s exposure to shares in illiquid and unquoted companies to zero and to redeploy that capital to more liquid companies in the FTSE 350 and primarily in the FTSE 100.

At the time of writing, Thursday 11th July, the fund was still suspended.

Update on 15th October 2019: The fund is to be shutdown with the winding-up expected to begin in January 2020.

 

Active versus passive

Whilst we don’t have an opinion on the Woodford suspension we thought this would be a good time to highlight some of the key differences between actively managed funds like the Woodford Equity Income Fund to passive funds such as the Exchange Traded Funds (ETFs) that we include in our portfolios in Moola.

 

Stock selection and fees

The Woodford Equity Income fund is an actively managed fund. This means that Mr Woodford and his team perform research into individual companies and select the ones that they think will perform well and fit into their investment strategy. Doing all this research and actively managing the fund takes time and hard work and often comes with promises of market beating returns. For these reasons actively managed funds are usually more expensive than passive funds. For example, the Woodford Equity Income fund management fee is 0.75% per annum.

Exchange traded funds (ETFs) are usually passive. This means that they track a stock market index. One example would be an ETF that tracks the FTSE 100 index. The FTSE 100 index tracks the 100 largest publicly listed companies in the UK. If you buy this ETF you would own small parts of all 100 shares in the same proportion that they are held in the FTSE-100 index. This involves less choice or decision making, but the result is similar, the investor is still invested in the market.

Most of the time passive funds can spread their investments broadly as it's not necessary to really like every share you invest in. This can lead to broader diversification (spreading your investments), which can make a fund less risky. Passive funds normally hold hundreds or thousands of securities. This way if one company performs badly relative to the rest of the shares in the fund it won’t overly impact the overall performance of the fund as it's only a small weighting in it.

Typically, passive funds involve less time and effort to manage them and are therefore generally less expensive than active funds. The annual management fee for an ETF that tracks the FTSE 100 index can be low as 0.07% per annum.

 

Unlisted stocks

The Woodford Equity income held some of its portfolio in unlisted or unquoted shares of companies. This means that they are not listed on a stock exchange such as the London Stock exchange. These are normally smaller companies who have not met the listing requirements of the exchange due to their smaller size. It can sometime be hard to buy or sell large amount of these shares in a short period of time and they are normally traded OTC (over the counter) rather than on an exchange.

It is holding these sorts of shares in the Woodford Equity Income fund that have played a large part in why Mr Woodford had to suspend the fund.

Exchange Traded Funds (ETFs) usually only include highly liquid publicly listed securities that trade on an exchange. If something is liquid it means it can be bought or sold relatively easy. These funds hold shares of companies that under normal market conditions can be sold or bought at any time during the trading day. As the shares are available to trade throughout the trading day, their prices are normally transparent and easy to work out

 

Fund Suspension

As the Woodford Equity Income fund is an Open-Ended Investment Company Mr Woodford, as the fund manager, has the permission to suspend trading in it as he has done.

ETFs are traded on exchanges. Therefore, under normal market conditions you should always be able buy or sell your shares of an ETF during the trading day. It is, however, worth noting though that trading in ETFs can be suspended but this is normally quite rare, and ETFs can also shutdown.

When selecting ETFs for Moola portfolios we ensure we only select ETFs from large reputable providers.

 

Pros and Cons

Both active and passive approaches have their advantages and disadvantages. Academic studies have typically shown that, perhaps surprisingly, active approaches, on average, tend to do worse over time than passive ones.

Because active investing often means higher fees and costs, this can reduce the performance of the investment by offsetting any benefit than an active strategy might have, on average.

Nonetheless, some active investors such as George Soros, Sir John Templeton or Warren Buffet have been very successful, and some active strategies do very well.

You can read more about the difference between active and passive investing here.

 

Remember to diversify

Many active and passive funds only hold assets of one type. For example, the Woodford Equity Income fund primarily invested in UK equities. It is therefore important to remember if your investing in either active or passive funds that you hold them in a diversified portfolio with different funds focusing on different asset classes and different regions.

Portfolios should usually have different asset classes in them such as equities, bonds, property, commodities or other alternative asset classes.

It is also important to remember to make sure your portfolio is diversified across different regions. If you were to only invest in the Woodford Equity Income Fund or an ETF that tracks the FTSE 100 you would only be getting exposure to UK companies. You are therefore at risk of the UK economy performing badly and your portfolio value suffering as a consequence. It is better practice to invest parts of your portfolios in economies all over the world such America, Europe and Asia as well as the UK.

You can read more about diversification here.

At the time of writing Moola portfolios consist of funds which have equities, bonds and commodities in them. They are also diversified globally so hold thousands of shares from companies all over the world including the UK, Europe, US, Asia as well as some in Emerging Market countries.

 

 


[1] Financial Times Newspaper – 8th June 2019 Page 9 – Woodford’s woes expose a flawed model by Patrick Jenkins, Owen Walker and Kate Beioley

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Written by Andrew Gordon

Andrew is the Head of Algorithmic Trading at Moola. He previously worked on the ETF Trading Desk for three and half years at Susquehanna International Group, a global quantitative trading firm. Andrew has a degree in Finance from Queen’s University Belfast.

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