When you don’t think it could get much worse for Neil Woodford, it does. And now it seems that the scandal around Britain’s most famous fund manager could pave the way for a new type of investment fund.
While a new fund had technically been in the pipeline for a while, the timing of the announcement – coming shortly after the Woodford fund suspension – is poignant.
Last week, the Bank of England governor Mark Carney waded into the debate about Woodford-style funds, saying that they are “built on a lie” – referring of course to the paradox of funds that hold hard-to-sell illiquid assets but which also claim to allow investors to take their money out whenever they like.
As we have seen with Woodford’s equity income fund, which is currently suspended until at least 29 July, it’s really not that simple. In fact, if lots of people flock to cash-in all at once, the reality is that your money could end up being locked in for months.
While Woodford’s certainly isn’t first fund to ever suspend (think back to the Brexit vote when several property funds were frozen for months), the former star manager has really highlighted the conflict between the structure of open-ended funds and the underlying assets.
Carney warned that half of investment funds have this structural mismatch. “Under stress, they may need to fire-sell assets, magnifying market adjustments and triggering further redemptions – a vicious feedback loop that can ultimately disrupt market functioning.”
Over recent weeks, the rallying call for regulators to take action to prevent another Woodford debacle has grown louder, though the launch of a new type of investment fund was perhaps not what most people had in mind.
Last week, the Investment Association published a report containing details of a new so-called “long-term asset fund”. A more detailed blueprint will be published later this year, but it’s thought that the fund would only allow investors to trade on a monthly or quarterly basis, rather than daily.
The industry seems less than enthusiastic about the idea, with some arguing that this tries to turn open-ended funds into something that they are not.
It also seems to ignore the fact that we already have a vehicle perfectly suited to holding long-term, illiquid assets in the form of investment trusts. Investment trusts do not have this inherent liquidity mismatch because they do not offer redemption. Instead, investors buy and sell their shares on the stock market, which means that trading has no impact on the underlying portfolio.
Ian Sayers, chief executive of the Association of Investment Companies (AIC), says that the proposals do not address the fundamental issues raised by the recent suspension of the Woodford fund. “We appear to be heading towards a world with less frequent redemption opportunities, more frequent suspensions, and the likelihood that open-ended managers will hold ever greater amounts of cash, reducing investment returns,” he says.
The AIC suggests that asset managers which offer open-ended funds holding illiquid assets should publish reasons why the structure chosen is in the best interest of consumers.
As Sayers adds: “There are many commercial reasons why asset managers favour open-ended funds over closed-ended funds, even when it is clear that the closed-ended structure is better suited to illiquid assets. We believe that the time has come to put consumers’ interests first.”
It’s strange that attention has focused on creating something new, rather than looking at how we can better utilise what is already available. And in fact, launching a new type of fund could create more problems than it solves.
For one, there are questions around how popular this long-term fund would actually be, as it fails to address the fact that investors want easy access to their own cash.
Adrian Lowcock, head of personal investing at Willis Owen, warns that he would be very cautious about recommending the fund, because many clients expect to be able to sell their investments and get their money back quickly. “Execution-only platforms are designed around this convenience, and for many of those investors, having some funds with monthly dealing makes the investment experience more complex.”
The worry is that investors could get confused by all the various rules that apply to different types of fund, and only really be reminded when they want to cash-in.
Meanwhile, monthly dealing doesn’t necessarily remove the issue of liquidity, because in extreme circumstances, the fund manager could still be forced to sell. And of course, a fund doesn’t have to hold a significant amount of illiquid assets to run into trouble.
It’s understandable that regulators want to be seen to be taking action, but perhaps the question is not whether we need more rules, but whether existing regulation is being properly enforced. Note that the FCA started investigating Woodford over his breach of the unquoted cap as early as February 2018.
Shaun Port, chief investment officer at Nutmeg, does not think that a new fund is the answer: “The Woodford crisis was avoidable through more appropriate liquidity and risk analysis by the fund manager, and through robust due diligence by those promoting the fund,” he says.
“It is not the fund structure that is at fault here, rather the way that the portfolio was structured and managed.”
But there is another way that creating a new fund misses the point.
Woodford has damaged investors’ trust in the industry, so for many people, the prospect of having your savings locked away in a long-term fund is unlikely to sound very appealing.
Indeed, Holly Mackay, founder of Boring Money, thinks that this is the bigger issue that needs resolving.
“Fund managers are very good at thinking that the answer to everything can be found by an engineer or an actuary, but a new product structure should be a secondary consideration,” she says. “The bigger problem is to sort out people’s mistrust of the industry. This means being clearer about what a fund is trying to do, and precisely how much it costs.”
At the moment, the launch of a long-term fund seems like an unhelpful knee-jerk reaction. For the investment industry and its regulator, it’s really time to reassess their priorities.