Yves here. I have a soft spot for stories about financial train wrecks, even though I suspect Americans will snigger at UK investors who didn’t read the fine print on their “equity funds.” However, the overwhelming majority of retail investors rely on sales pitches and are lucky enough that US securities laws are so strong that even our pathetic SEC has not yet made them a dead letter.
But consider: those short and leveraged ETFs that remain popular with small traders were a cause of concern before the crisis, since in many cases their liquidity backstops were coming from hedge funds (usually in the form of options). I knew several small fund managers who were sitting on very nice paper ETF profits who were worried the funds might not perform when they were ready to close out their positions. The fact that these risks worked out didn’t mean they were good risks to have taken. In pretty much all cases, there were other, admittedly more clumsy ways for these investors to have put on similar wages…and without also running as much basis risk as you do with ETFs, particularly in volatile markets.
By Nick Corbishley, originally published at Wolf Street
There’s still no sign of relief for the hundreds of thousands of investors whose money is trapped in one of the UK’s biggest equity funds, the Woodford Equity Income Fund. The fund is supposed to offer its shareholders daily liquidity, meaning they can take part or all of their money out any day of the week. But that was before a slow-motion (but accelerating) run on the fund forced its manager, hedge-fund legend Neil Woodford, into taking the last-gasp decision, on June 3, to place a ban on redemptions. Since then, investors have been unable to access their money. And it’s not clear how much longer this could go on.
The problems at Woodford have raised serious questions about just how liquid other equity funds in the UK may be. In the past few days, UK’s biggest broker, Hargreaves Lansdown announced that it plans to remove the Lindsell Train UK Equity Fund, the largest managed UK shares fund, and the Lindsell Train Global Equity Fund, from its Wealth 50 Best List due to liquidity concerns, which prompted shares in Lindsell Train Investment Trust to tumble 22% on Friday.
The £7.1 billion LF Lindsell Train UK Equity would need an estimated 13 working days to sell 20% cent of its portfolio if trading conditions severely deteriorated, according to Morning Star. Woodford’s shareholders have already had to wait almost 3 times that long, and there’s still little sign of light at the end of the tunnel.
The Woodford Equity Income fund has performed terribly for the past two years. Bad bets were made, often on unlisted assets, resulting in big losses, which in turn triggered a cascade of redemptions as the sharpest investors began yanking out their money. The total amount under management at Woodford has steadily shrunk by almost two thirds since 2015, from £10.2 billion to £3.7 billion.
At the very least, Woodford’s investors will have to hang on for another three agonizing weeks, when the decision to gate the fund is scheduled to be revisited. When the last 28-day review period came up, around a week ago, Woodford told the UK’s Financial Conduct Authority that the fund was still not ready to reopen its doors.
“Of course, we understand that people want access to their money, they are very frustrated by not being able to deal in the fund. But we are using the time . . . to ensure we get the right outcomes for our investors,” said Mr Woodford in a video statement to investors on Monday.
Woodford’s words did little to soothe the nerves of the fund’s shareholders, who include at least three local authority pension funds. Their biggest concern is that by the time they’re actually able to access their money, much of it will have gone due to the steep discounts Woodford will be forced to accept on his holdings of unquoted and illiquid assets.
Most of Woodford’s liquid assets are already gone having been sold off when the giant flood of redemptions began. By this spring, only three of the fund’s 105 holdings were FTSE 100 companies, and only 26 paid out dividends, which is highly unusual for a fund that is supposed to be almost exclusively devoted to equity-income.
In recent weeks Woodford has reduced his holdings in Raven Property and Horizon Discovery, two long-term investments, as well as other listed companies, including BCA Marketplace, New River Reit and Oakley Capital Investments. But most of the remaining assets are highly illiquid, which means selling them will be a lot more difficult, unless at a very heavy discount.
By EU law, equity funds like Woodford’s are allowed to hold a maximum of 10% of their portfolio in transferable securities that are not dealt in an “eligible market” such as the FTSE 250. To get around this rule, Woodford reportedly bundled up his fund’s illiquid unlisted assets and listed them on the minuscule Guernsey-headquartered International Stock Exchange, which despite its impressive-sounding name has barely any trading activity at all.
This was enough to lend his most illiquid assets the appearance, albeit flimsy, of liquidity. The move was within the letter — though not the spirit — of the law, according to the FCA chief executive Andrew Bailey. Mr Bailey told the Commons Treasury select committee that Woodford Equity Income fund was “sailing close to the wind,” adding that “listing something on an exchange where trading does not actually happen, as far as I can see, does not actually count as liquidity.”
Yet all the time Woodford was doing this, no one at the FCA kicked up a fuss. And Hargreaves Lansdown sent more than £1.6 billion of investors’ money Woodford’s way. It even kept on recommending his funds up to the very day Woodford gated his flagship equity fund. In total, around a quarter of Hargreaves customers, just under 300,000, are exposed to Woodford Equity Income, either directly or indirectly.
The brokerage house now faces allegations of conflicts of interest. Mark Dampier, the 62-year-old research director at Hargreaves who has long been one of Mr Woodford’s biggest cheerleaders, has close ties to Woodford dating back more than 25 years. As for Hargreaves’ billionaire co-founder, Stephen Lansdown, he was until 2017 deputy chairman of the same International Stock Exchange in Guernsey that Woodford used to dodge limits on illiquid investments, and still owns almost 10% of the company.
“Hargreaves failed to manage some serious conflicts of interest and should have put in place internal controls that prevented it from having such a large exposure to Woodford Equity Income,” Anthony Morrow, chief executive of financial advice service OpenMoney, told the FT. By Nick Corbishley, for WOLF STREET.
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