Woodford saga gives investors a lesson on liquidity risk

From the Financial Times:

Why is it that whenever a buccaneering titan falls from grace, most blame is levelled at that individual? Sure, when assets halve in two years — the case with Neil Woodford’s Equity Income fund — the person managing the money bears most responsibility. But investors have liability, too.

Woodford’s now-frozen fund ploughed money into illiquid assets but then too many investors, raging about underperformance, pulled cash out. But it is not as though these investors were oblivious to Woodford putting their money into illiquid assets.

The issue is the fact that investors struggled to understand just how illiquid these assets were and, importantly, when to pull their cash. Investors require regular insights into strategy. They cannot rely on net asset value, which makes it next to impossible to understand intrinsic value. Instead investors need a detailed view of what is driving fund performance.

In this way, the headteacher who has retired to leafy Sussex, and is still paying fees to Woodford’s frozen fund, could have known the illiquidity involved and been able to make a call on withdrawal. It boils down to individuals being able to assess the time it will take to liquidate a fund, which will be longer if the fund is invested in non-listed equities. While regulators are forcing funds to publish more information, one cannot rely on rulemakers alone. Investors have to demand far more from their fund manager. This should include detail of positions taken as well as the type of exposure.

An institutional investor putting in £500m will require this, so why shouldn’t midsized or small investors? Some funds will refuse to give such insight but these are rare. About $30tn of the $80tn of assets under management, 37 per cent, is in funds that promise daily liquidity despite investing in potentially illiquid assets. With other funds heavily invested in illiquid assets, Woodford should not be seen as an isolated incident. As the industry digests the evidence of Andrew Bailey, the Financial Conduct Authority chief, to the Commons Treasury select committee, investors have to decide if they know enough to hold fund managers to account.

Individuals with a few hundred thousand in an active fund need to ask questions about liquidity risk. If fund managers refuse and investors still commit their money, they must accept some blame in the event of a collapse.

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