What can we learn from Woodford now the dust has settled?
Spotting signs that other UK funds could suffer similar issues
While we have not had an allocation to the Woodford funds in any format, having removed the manager from our portfolios in 2011, we are aware many advisers have clients that have invested directly into them.
The situation remains unclear as to when renewed access might be granted to the fund, but now the dust has started to settle, we thought it would be worthwhile to provide an update on the situation from our perspective.
An adviser recently asked us whether other UK funds held in our portfolios could potentially have similar issues to Woodford.
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This is a good question, and one we've been looking at closely both in respect to the funds we hold and those that remain on our radar. The list of funds that are on our radar includes those we might be considering for future inclusion, plus some higher profile ones.
Following the closure of the Woodford fund, we contacted each of the UK funds we hold and requested reports on liquidity, market cap breakdown and fund size/investor base.
Liquidity
A liquidity report gives us an indication of how easily a fund can liquidate its assets to allow for redemptions. The report helps us determine what percentage of a fund is in 'liquid' assets.
The liquidity reports demonstrated that our combination of UK funds can liquidate (on average) over a third of their total assets in one-to-two days and circa 80% of their assets in 20 days based on 20% to 30% trading volumes.
The unknown question for context, of course, is how big a widespread liquidity event would be, and unfortunately this will remain unknown until such an event happens. In simple terms, there could be a single fund liquidity issue such as the Woodford one, or something on a larger scale, which could potentially embroil multiple funds with similar investment profiles. Whether it is a liquidity issue or just something else like market or sector reorientation, multiple funds in a sector approach can potentially help dissipate some risks from most foreseeable scenarios.
Market cap breakdown
We use this information alongside the liquidity report to assess portfolios' total assets in smaller cap stocks. It is, in our opinion, worth looking at the cap breakdown separately, as many of these smaller stocks can trade frequently and without problem until an issue arises. At this point they can be much harder to sell than expected and suddenly the price on the screen is not the price you can realise. A pertinent point to consider here is that it is not just about your ability to sell an asset, but also the price you are able to receive for that asset.
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As expected, those funds with a smaller cap bias are rated as less liquid. To put that in the context of our UK funds, those with a small cap bias account for 6% of the overall portfolio and 35% of our total UK holdings. The question then necessarily arises, why hold small-cap biased funds at all? The answer is performance, and between July 2009 and July 2019 the FTSE 100 has produced a total return of 150%, whereas the FTSE 250 has returned 240%.
Fund size and investor base
We have highlighted potential fund size issues for many years, and it is worth considering that funds which rapidly gain assets can lose them at the same speed or even quicker. Smaller funds may find it easier to offload assets should they face redemptions.
It also seems fair to say that smaller funds are more protected from the potential of negative media glare. This might be an advantage, even if it is largely unquantifiable. The fact Neil Woodford is probably the most high-profile manager in the UK certainly did not help the redemption situation once it started to go wrong.
For the UK funds currently being used by IBOSS we looked at the existing investor base. What we want to avoid is owning a fund where much of the fund is held by a few very large investors. We witnessed the dangers of this first-hand when Hargreaves Lansdown distanced themselves and SJP took their segregated mandate from Woodford. The average fund size among our UK equity portfolios is £840m, with the largest - Henderson UK Absolute Return - at an AUM of £2bn, and the smallest - Unicorn Outstanding British Companies - at £116m.
Looking at fund size, we continue to avoid the largest funds in the sector, many of which are run by so called 'star' managers. The definition of what makes a star manager is open to interpretation. One rough guide might be somebody a retail client is more familiar with. Often this is coupled with somebody the media would feel is of enough interest to a significant percentage of their readership and/or who will increase click-through rates.
The concern here is that if a star manager's underperformance makes the mainstream media, then the manager could see additional complications from unwanted interest and, potentially, panic selling.
