Clare Flynn Levy, CEO of Essentia Analytics, explains why the Neil Woodford saga is not about transparency; it is more to do with unchecked behavioural biases.
It is a tale as old as time: 'star' fund manager grows too fast, their style starts drifting as they're increasingly stretched, and it all ends in tears.
Careers ruined, investors outraged, decision-makers humiliated, and everyone doing lots of finger-pointing.
The Neil Woodford saga is the classic fallen star story, with all the usual twists and turns but with some modern touches such as a hedge fund-style liquidity crisis.
But none of it is unprecedented and with word on the street that for several years Woodford was deviating from a traditional equity income mandate, the new revelations are not a surprise either.
Dotting the i's
How did this drift get so extreme and destructive?
The investors who allocated the largest pots of capital to Woodford undoubtedly had access to analysis of his performance and risk-taking - including traditional attribution analysis that reversed out where his performance (or underperformance) had come from, and what sorts of risk exposures he had borne in getting there.
For large allocators, this stuff is bread and butter.
However, this crisis shows us that bread and butter analytics are simply not enough; that basic analysis would have shown his style drifting as his assets grew.
What it would not have shown is the storytelling, biases and incentive structures that enabled investors and Woodford to ignore the information for so long.
The allocators of capital to Woodford knew questions were being asked several years before they decided to pull the ripcord on their investments. So why didn't they do it sooner?
The financial incentives of wealth managers and investment product producers will likely prove to have been a contributing factor, as some have observed.
It is pretty clear, though, that the inaction pervading the Woodford situation was due to something much deeper; there was an enormous amount of behavioural bias baked into this particular pudding.
Why a fund manager's ideas run out of alpha after a certain point is a combination of numerous factors, including assets under management (AUM) growth.
As hedge fund investors know, it's hard to keep generating alpha, even in a liquid strategy, beyond a certain AUM level. But alpha decay happens even when AUM is small and portfolios are liquid.
As any investor who has experienced a 'round trip' before can attest, when a fund has made them money, they are more likely to give the management team the benefit of the doubt when they are losing money.