Via Financial Times

A year ago today, a group of local government officials and retired council workers in Kent made a momentous decision that would trigger the downfall of Britain’s most famous fund manager and spark Europe’s biggest investment scandal for a decade.

Kent county council’s termination of a £263m mandate managed by Neil Woodford started a dramatic series of events culminating in the former star stockpicker being forced to close the doors of his eponymous investment business, rocking confidence in the UK’s £9tn asset management sector.

Yet one year on, many are critical about the lack of progress made in fixing the shortcomings that led to Mr Woodford’s demise. “The more profound implications of the Woodford crisis have been brushed under the carpet,” says Paul Myners, the former City minister.

According to Lord Myners, the scandal “exposed the design faults” of investment funds by illustrating “the peril involved in allowing illiquid assets to be held in open-ended funds that permit daily dealing”.

Kent’s large redemption request sparked a liquidity crunch at Mr Woodford’s flagship Equity Income fund. His high exposure to hard-to-sell assets meant he did not have the cash to pay Kent back, forcing him to suspend the fund and block hundreds of thousands of investors from accessing their cash.

The suspension, a rare event for a retail equity fund, served as a death knell for the fund, the liquidation of which was ordered four months later, and for Mr Woodford’s investment empire.

The events shone an uncomfortable light on the active asset management industry, exposing flaws in fund liquidity and the cult of the star manager.

The risk of fund liquidity mismatches — when a fund cannot sell assets quickly enough to meet investor redemption requests — became a flash point in the aftermath of the fund suspension, with the then-governor of the Bank of England, Mark Carney, attacking such funds as “built on a lie”.

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The UK’s Financial Conduct Authority indicated last autumn it would look again at daily dealing. It would also examine the problems posed by institutional and retail investors owning holdings in the same fund, as was the case with the Woodford fund. It floated the possibility of introducing financial penalties for daily fund withdrawals.

Yet the FCA has stopped short of banning daily traded funds from investing in illiquid assets. The UK could opt to change its fund rules after the Brexit transition, but it does not have the power to change the Ucits fund rules, the EU directive that governs most European retail funds.

Ryan Hughes, head of active portfolios at investment platform AJ Bell, says: “The fact that holding unquoted assets is still allowed in the rules is a problem. I accept that the regulatory wheel turns slowly, but regulators could have been more vocal about this issue, as failure to address it leads to problems that undermine investor confidence.”

The recent suspension of eight daily traded UK property funds during the coronavirus-induced market turbulence highlighted that the threat of liquidity mismatches has not gone away and is particularly acute at times of market stress.

Tentative signs exist that market practices are evolving in response to investor unease with hard-to-sell stocks. Merian Global Investors, the £15.7bn group, has scaled back unlisted investments in its UK small and mid-cap fund range, while Invesco has pledged to offload unquoted stocks from Mr Woodford’s former funds, run until recently by Mark Barnett.

But Mr Hughes says that no fund managers have moved away from the daily traded fund format because there is “no first-mover advantage” for doing so. “This will have to be led by the regulator,” he says.

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Peter Sleep, senior portfolio manager at Seven Investment Management, says a lack of progress on liquidity risk is not the only sign that asset managers have yet to learn the full lessons of the Woodford scandal. “The industry is guilty of many of the sins that created the environment for Woodford to fail,” he says.

These include the widespread fixation on star managers as well as an overemphasis on funds with high active share, meaning that they diverge significantly from their benchmark, as Mr Woodford’s did. This culture pushes investors into higher-risk funds that they are not well equipped to deal with when things go badly, says Mr Sleep.

Efforts are under way to improve governance standards across the fund industry. The FCA is probing authorised corporate directors (ACDs), service providers tasked with overseeing funds, over fears they are beholden to their paymasters. Link Fund Solutions, Mr Woodford’s ACD, attracted criticism for failing to act sooner to protect investors in the fund.

Despite this, no concrete action has been taken to stamp out the conflicts of interest lurking in the cosy relationships between platforms and fund managers — an issue brought to light by Hargreaves Lansdown’s promotion of Mr Woodford’s fund in its list of recommended investments until the day it suspended.

Hargreaves is in the process of revamping its recommended fund list in response to criticisms. But “best buy” lists in general remain unregulated and there is little oversight of the criteria behind a fund’s inclusion.

“It’s disappointing that, 12 months on, all of the questions posed regarding the influence of best-buy lists as a result of the Woodford affair remain unanswered,” says Mike Barrett, consulting director at research company the Lang Cat.

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Investors will have to wait for the conclusion of the FCA’s investigation into Woodford Investment Management and its ACD for explanations of what went wrong in the run-up to Equity Income’s suspension.

But questions remain about the FCA’s role and why it did not intervene sooner despite repeated warnings of the fund’s liquidity problems. “The FCA waited for the accident to happen rather than recognising there was an issue before,” says Lord Myners.

Woodford’s dramatic fall from grace

May 31

Kent county council pension fund decides to redeem its investment in the Woodford Equity Income fund

June 3

Equity Income fund suspended

June 18

FCA opens formal investigation into Woodford Investment Management

October 15

Link, the Equity Income fund’s ACD, orders its liquidation and sacks Mr Woodford as manager; Mr Woodford resigns as managers of his remaining two funds

October 24

Schroders appointed to take over the former Woodford Patient Capital Trust

December 20

Standard Life Aberdeen appointed to take over the former Woodford Income Focus fund

January 28

Equity Income fund investors told they will receive £2.2bn of their money back, representing 75 per cent of the fund’s portfolio

March 12

Equity Income fund investors informed they will receive £141.7m, equivalent to 20 per cent of the remaining fund’s assets