An industry built on a lie

WheN the Bank of england Governor Mark Carney remarked that open- ended investment funds are ‘built on a lie’, he wasn’t kidding.

It is a pity the Financial Conduct Authority and european regulators were not listening carefully.

The spectacular collapse of Neil Woodford’s empire has exposed gaping holes in regulation and monitoring. Funds such as the ‘flagship’ Woodford equity Income are not open at all. A mismatch of long-term investment and the ability to pull out cash makes that impossible so a time-limited redemption policy, similar to that which operates with bank deposits, is required.

Woodford exposes other weaknesses. The hargreaves Landsdown (hL) Wealth 50, the platform’s list of chosen funds, has proven untrustworthy. It needs to be backed up by independent scrutiny of the analysis and research which provides a gateway to trusts chosen to be among the privileged few.

As critically, Andrew Tyrie, the Competition and Markets Authority chairman, should probe the charging structure used by hL and others. The discounts offered on favoured funds, and then part-clawed back by hL’s management charges, look to be anti-competitive, especially when the funds concerned appear on the Wealth 50 list.

There also is something dreadfully wrong when investment funds, aimed at consumers and public bodies, make investment decisions without unbiased scrutiny.

Similarly, the composition of the Woodford Patient Capital board, where members were closely involved in companies in which they were invested, is far too cosy and an open invitation to potential abuse.

Better disclosure and robust governance need more than light-touch supervision.

Borrowing menace

BACK in 2004-05 no one saw the risk building around sub-prime mortgage securities that eventually turned into the cluster bombs which came close to breaking the whole financial system.

The International Monetary Fund’s top regulator, Tobias Adrian, thinks the same menace could be building up in a different part of the financial firmament and wants to catch the falling star.

The driver for risk this time is corporate borrowing. Much the same as last time, the search by investors for better returns has unleashed animal spirits. When interest rates look to be permanently low, as now, asset managers seek high-yielding assets that boost performance and drive bonuses and ambitions for bigger yachts.

This inevitably leads them down a dangerous path. Ask Woodford savers.

The potential exposures are enormous and the risk this time has shifted from the banks, which are tightly supervised, to a range of financial institutions including insurance companies, pensions, private equity groups, open- ended investment funds and much else.

The scale of what is at stake is sobering. Companies and firms controlled by private equity have taken on debt as if there is no tomorrow, apparently confident that loans can be serviced.

The Fund estimates the corporate borrowing at risk in the US, China and in europe stands at an alarming £15trillion – a number too large to imagine. In most cases this is owed by firms unable to cover interest costs with earnings.

Some of this debt has been packaged into securities (collateralised loan obligations) and proved tempting to fund managers. If the world continues to grow it may be all right on the night as earnings strengthen.

But if the global economy slips into recession then there could be a 2008-09 style implosion. It may still be possible to erect safety nets.

These should include more rigorous bank controls over the granting of commercial credit, greater liquidity and capital buffers at insurers and other non-banks and slowing capital flows to risky emerging markets.

But it could well be too late.

Fidelity fumble

NeIL Woodford is not the only star stock picker in deep trouble.

Billionaire Ken Fisher, who now manages funds for global giant Fidelity, is on the cusp of being sacked after telling an investor conference that landing a new client is ‘like getting into a girl’s pants’.

The Michigan state pension has pulled out $600m. Philadelphia followed and other state funds are considering their position.

Justice is quick in US fund management.