It’s not a good feeling when an institution you trust with your money won’t give it back to you; it’s the sinking feeling that thousands of investors in a UK mutual fund called Woodford Equity Income are experiencing, but is this yet another opportunity for bitcoin to show its worth?.
“Not your keys, not your bitcoin” is the mantra of crypto faithful, popularised by industry influencer Andreas Antonopoulos.
To take full custody means having full control of your private key. You are your own banker, assuming you are happy to take on the custody risk.
With that in mind, the implosion of this large mutual fund – where investors pool their money in a fund run by an “expert” manager – has sent shockwaves through the UK investment industry, and for followers of crypto (and others) has engendered a large dollop of schadenfreude, as investors discover that their money is effectively in someone else’s hands.
The “told you so” folks, after finishing-up laughing at others’ misfortune (not a good look but tempting), are puzzled why anyone would put their money into the Woodford Equity Income fund run by star manager (fallen star manager) Neil Woodford in the first place.
The fund, which opened for business in 2015, made money in that year but has lost it in each subsequent one, with those losses widening against its FTSE All-Share benchmark to 16% so far this year, according to fund data and ratings company Morningstar.
Suffice to say it is languishing in the bottom quartile of the performance tables against its peers, yet at one stage the fund had assets of £11 billion ($14 billion) under management.
At the beginning of last week investors were stopped from taking their money out of the fund as a rising wave of redemptions of units in the fund gathered pace. Now sized at just £3.7 billion, the final straw seems to have been a request by Kent County Council to withdraw its £263 million invested in the fund.
Neil Woodford’s fund (one of three vehicles) is misnamed.
Most investors would take an equity income strategy to be one in which are fund invests in established firms, ideally highly cash-generative and paying a regular dividend income.
Indeed, Woodford had earned his stellar reputation from his time at Invesco Perpetual, where he famously shunned tech firm capital growth in favour of a “value” approach, thereby side-stepping the dotcom bubble implosion of 2000, prefering unloved stocks such as those of tobacco companies.
However, he began to believe what others were saying about him – that he had the Midas touch. So he set up his own company and the millions began to roll in – both to his funds and to his pocket.
He started to veer a way from investing in income-generating companies (although they still have a place in the Equity Income fund) and began to make large bets on early-stage and highly speculative firms.
And the mature firms he did pickwere in companies that went on to make gigantic losses, such as sub-prime lender Provident Financial and outsourcer Capita.
Brexit bet not working out – vicious circle like a bank run
His big macro idea that Brexit would be a godsend for the UK economy, which would see his UK smaller company picks shine, proved to be mistaken also.
But here is the crux of the matter – when investors starting taking their money out, the investments in small illiquid companies not quoted on any public market became a big problem.
The only way to meet the redemptions was to sell the liquid holdings. Such forced sales had the effect of increasing the proportion of the fund that was in the unlisted illiquid assets.
A vicious circle was in effect. Hedge funds noticed what was going on and they started shorting the companies they figured Woodford would have to start selling the shares of, accelerating the downward spiral – in a fashion not dissimilar to a bank run.
But the warning signs about Woodford’s flagship fund have been flashing red for months if not years.
There was a clear mismatch in an open-ended mutual fund that required instant plentiful liquidity to meet investor redemptions on the one hand and the large proportion of illiquid assets it held on the other.
There is a rule under EU securities law that prevents such funds from holding more than 10% in unlisted companies but Woodford found creative ways of getting around that by, for example, listing some of them on the Guernsey International Stock Exchange.
He also got his Woodford Patient Capital investment trust (which is a closed-ended vehicle with shares that trade on the stock exchange) to buy some of the illiquid holdings in an unusual swap in which the fund received shares in the trust.
This was all perfectly legal but many would say against the letter of the law.
FCA eye on crypto fraudsters but not investment management stars?
All this was going down while the Financial Conduct Authority was busily doing not very much at all, although it did find time to alert retail investors to the loss of £27 million to fraudulent crypto companies.
Those warnings are of course welcome, but where is the same vigour on display when it comes to the big players crypto investors might ask? The FCA is planning to run adverts in the UK warning about online trading scams in crypto but what about the investment fund governance allegedly endulging in less-then-ethical practices in plain sight?
The main UK financial regulator has belatedly issued a statement saying that it is looking at the Guernsey arrangements to check on “compliance with the relevant rules required by the Ucits Directive [EU security rules]”, while the Guernsey stock exchange says it has “made several attempts to contact the FCA back in April 2009 but with no initial response” as the blame game mounts.
But the FCA has said nothing about what it thinks about the core problem of the mismatch in liquid liabilities and illiquid assets.
Meanwhile investors who can’t access their money are still paying fees that are reportedly earning Woodford Investment Management £100,000 a day in fees.
Certainly, rebalancing the portfolio will cost money, but it might have been thought that a minimal good will gesture might see it meet those expenses out of its own purse.
Neil Woodford has made an apology, broadcast no YouTube, but the nervousness preformanace should probably have been subject to a retake.
But he’s the boss and he presumably knows best, which highlights another problem with investment stardom – what crypto people would call the weakness of centralisation and its necessary single point of failure.
The IDEX crypto exchange holding that wasn’t
Returning to the unlisted holdings, The Sunday Times ran a story (paywall)on precisely that issue a few months ago.
The story in part reported: “A number of the businesses in the portfolio may surprise investors. They include Raven Property Group, a Russian developer; Sabina Estates, established to build high-end homes in Ibiza; and Idex, a cryptocurrency exchange.”
I dutifully reported this news in a crypto roundup and was then contacted by Woodford Investment Management’s head of corporate communications asking that I change the report, as the Sunday Times had got it wrong and the holding was in fact a different IDEX – a Scandinavian company in the digital ID business.
I moved to get the article corrected and the headline changes as Woodford featured in it. But such was the alarm in the Woodford camp that on 7 March Farrow wrote:
“It’s 10am and it’s still up. This really isn’t very helpful. We have had to put a tweet out this am to clarify to everyone. Can you please amend or take down while you change”
Clearly the firm’s proactivity on that matter was perhaps indicative of a nervousness about an investment highlighted that, if true, would have been one of the more speculative holdings in a surprisingly speculative portfolio.
Unfortunately for the circling media today and worried investors, the comms team at Woodford is no longer quite so responsive, or not in the manner to be hoped for.
You thought crypto was risky, try cold fusion
Other investments that catch the eye include Industrial Heat, which comprises 2.3% of the fund (8.9% of the trust according to the February factsheet).
Industrial Heat claims it is researching a breakthrough in energy science around cold fusion, but most scientist thinks it is junk science. In a nutshell Industrial Heat says it is working on the impossible – getting more energy out than is put in, in contravention of all the laws of physics – and they say crypto is speculative!
Pre-empting the crowing of crypto enthusiasts comes FT Alphaville’s Izabella Kaminska piece entitled: If Neil Woodford had been operating in crypto…, to reminds us all that crypto hedge funds have been shuttering funds at a rate of knots, as they ”sneakily suspend redemptions in a bid to buy time until the market “corrects” or at least until a large vested interest can be persuaded to part with some capital to provide a floor to assets you are invested in”.
That’s true but there’s a big difference between hedge fund investors getting shut out of funds and the ordinary folks who fell for the marketing of the genius that is Woodford. And of course there’s also a marked difference between the well-established investment fund industry and the nascent unregulated world of crypto.
And then there’s the cheerleading by certain investment platforms (I will be careful here what I say as I work for an investment platform in the UK).
The largest player in the UK investment platform business, Hargreaves Lansdown, has had the Woodford Equity Income fund on its favourites list since launch, despite its increasingly dire performance. It only removed the fund on the day it barred withdrawals.
Being the largest player, Hargreaves has been able to get fee reductions from the likes of Woodford, which it passes on to platform customers. Why would Woodford make such reductions? Probably because it hopes that Hargreaves customers will be attracted to put money into its funds by the generous fee reduction. Fair enough.
But cynics might say that the Woodford inclusion on Hargreaves’s Wealth 50 was an unwritten expectation on the part of Woodford, and one which created a conflict of interest between the platform’s commercial interests and those of its customers.
Also, the fact that its head of research Mark Dampier sold shares in the company on 16 May to the of £600,000 and his wife offloading £5 million, has left a sour taste in the mouths of its customers.
Active management in the dock
Working for a competitor as I do, I should leave it there and remind the reader that nothing illegal has been done and Hargreaves’ customers have over the years remarked on its excellent customer service.
The whole sorry episode has perhaps put another nail in the coffin of active fund management.
Exchange traded funds and other passive vehicles have been growing in popularity as the realisation dawns that retail investors don’t need to be paying fat fees for underperformance.
In truth the bull market has meant it’s been easy to look good as an active fund manager, but as Warren Buffett puts it, you don’t see who’s naked until the tide goes out.
Banks have already got a poor reputation with the general public and crypto people in particular.
This latest news from the UK fund investment industry is likely to see yet more people conclude that financial independence requires running your own money.
With trackers for all major markets and the most alternative of alternative markets too – (and there are exchange traded notes trackers available for bitcoin and Ethereum) – it’s easy even for those with little understanding of stock markets and other asset classes to get low-cost passive access.
Warren Buffet when asked what his wife should invest in upon his parting this world, he said put it in a S&P 500 tracker. His words exactly were: “Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund.”
After his lunch with Tron’s Justin Sun, crypto believers will be hoping there might be 1% for crypto in that portfolio asset allocation.
Just as the bull market might be on its last hurrah, active management couldn’t have a worse reputation, as investors begin to suspect that star managers are really just lucky and it is better to basically stay in the market as long as possible with a tracker.
And when it comes to accessing an asset class and exercising direct control over your ownership of it, there really is no other asset that can compete with bitcoin.
Gary is the cryptocurrency analyst at UK investment platform interactive investor and this opinion piece is written in a personal capacity