Lessons in fall of star fund manager

Neil Woodford tripped up by lack of liquidity and poor risk management, leaving him with little room to manoeuvre when markets turned against him

A failure in the oversight of a top fund manager in the UK has left investors and the industry there reeling from news that its greatest star of the past two decades is now a fallen one, writes Laura

du Preez on the Money

Afailure in the oversight of a top fund manager in the UK has left investors and the industry there reeling from news that its greatest star of the past two decades is now a fallen one.

Neil Woodford — once a manager who delivered market-beating returns so frequently he received a CBE for services to the economy and once managed £33bn — has been fired and his £3bn Equity Income Fund is to be closed.

His performance record faltered in mid-2017 after a series of bad stock picks and uncertainty over the Brexit referendum, forcing him to sell larger, more liquid holdings in the Equity Income Fund which increased his holdings in illiquid, unlisted start-up companies.

In June 2019, he was forced to suspend withdrawals from the fund, and in October the authorised corporate director decided not to reopen the fund, to the detriment of thousands of investors.

After Woodford left Invesco Perpetual, one of the largest investment managers in the UK, to start his own investment company, he drifted away from the investment style that had built his reputation: picking good listed companies able to pay good dividends. Instead, he began investing in smaller unlisted start-ups, which can be very difficult to sell quickly.

At 10% of a fund, SA’s limit on holdings in unlisted securities is the same as it is for UK funds. However, Pieter Koekemoer, head of personal investments at Coronation, says SA funds rarely invest in unlisted equities the way Woodford did. They use debt instruments to invest in unlisted companies instead.

But, he says, any assets in which managers invest — even listed ones — can become distressed and difficult to sell, as debt issued by African Bank did in 2014, and the suspension of shares of Tongaat Hulett did earlier in 2019.

SA investors are most likely to experience liquidity issues with bonds and investments in other parts of Africa, he says.

Stanlib’s Africa Property Equity Fund, for example, closed in 2017 but has still not been able to sell illiquid investments in Zimbabwe, Mauritius and Nigeria.

Victoria Reuvers, senior portfolio manager at Morningstar who analyses and selects managers and constructs portfolios for financial advisers, says Morningstar uses local funds that meet its strict liquidity criteria. The funds covered by their team have displayed good management with regards to risk management, including liquidity of their underlying holdings, she says.

SA is behind the curve in terms of what unit trust funds are allowed to invest in, and this benefits investors, she says.

Glacier by Sanlam’s head of research, Francis Marais, and its research and investment analyst, Dean de Nysschen, say a fund does not have to be massively exposed to unlisted or illiquid assets to run into trouble when many investors withdraw — 18% of Woodford ’ s fund was in illiquid assets at the end of 2018.

That Woodford didn’t anticipate the magnitude of redemptions and had little room to manoeuvre when markets turned against him raises questions about his fund’s risk management, they say.

Sangeeth Sewnath, deputy MD of Investec, says as part of its risk management process, a unit trust management company must stress-test the liquidity when performance is poor and investors pull out. Management companies cannot expect that a fund will continue to be a best-performing one and continue to take on new investments, he says.

In the UK, funds must have an authorised corporate director who checks that a manager does not stray from his or her stated investment philosophy and stays within the fund mandate and the law. In SA, unit trust management companies fulfil this role.

Sewnath says Woodford appeared to have had undue influence over the authorised corporate director’s board. The checks and balances were not as rigorous as they should have been.

SA recently had its own governance problem in a boutique unit trust fund that operated on the licence of another unit trust management company. MetCI, the collective investment scheme business in the Momentum Metropolitan Holdings group, was fined R100m for, among other things, contravening the Collective Investments Schemes Control Act and failing to have proper risk management processes in place to manage and exercise proper control, oversight and governance of the Third Circle MET Target Return Fund operated on its licence.

The fund lost 66% of value to derivative positions in the equity market over three days in December 2015 when former finance minister Nhlanhla Nene was fired, sending markets into a tailspin.

Like the Woodford case, there should have been more robust checks in the fund, Sewnath says.

Koekemoer says governance failures are more prevalent in funds managed by third parties on another unit trust manager’s licence, but the fine imposed on MetCI will make unit trust companies increase their focus on risk management.

He said that despite the proliferation of new boutique managers operating on other companies’ licences, very few have attracted large amounts of investment.