The UK’s most celebrated fund manager, Neil Woodford, has been sacked following a string of poor decisions. His fund’s failure leaves investors and pension fund members with potentially heavy losses – and many questions. Article by Nick Green.
The investment funds managed by Neil Woodford are to be wound up, some five months after their trading was suspended. The funds include the flagship Woodford Equity Income Fund, which will begin the process of closing down from 17 January 2020, under the new name of the LF Equity Income Fund now that Woodford has been dismissed.
Once among the UK’s most celebrated fund managers, Neil Woodford has suffered a humiliating fall from grace. With a long reputation for making bold calls that paid off, he famously dodged the dot-com boom and bust, and was one of the few to predict and profit from the financial crisis of 2008. But his most recent gambles failed to repeat the magic: investing in small unlisted companies, illiquid (hard-to-sell) assets and, most recklessly, betting on a speedy resolution to Brexit. When this didn’t happen, Woodford’s winning run hit the skids.
How Woodford lost his magic touch
The Woodford Equity Income Fund went from a remarkable 16 per cent return in 2015 to being the UK’s worst-performing equity fund. In the wake of the EU referendum it fell to nearly minus 20 per cent, overall recording a 66 per cent loss, more than three times the losses of the next-worst performer, according to Willis Owen. Woodford’s complacent attitude to Brexit may have been a major factor; he was quoted pre-referendum as saying, ‘I think it's really hard to see any credibility in an argument to stay or to leave [the EU] constructed around economics. I think it's a nil sum game.’ Woodford assumed that a speedy and positive Brexit deal would revitalise his flagging UK stocks that had proved vulnerable to Brexit gloom. But three years of uncertainty put the damper on his predictions.
The fund’s poor performance caused many investors to cash out, which left him over-dependent on the assets that were hardest to sell. When more clients – including a local council pension fund – tried to claw back their investments, Woodford was forced to halt withdrawals altogether. Currently there are still hundreds of thousands of investors who have money locked away in the fund, who stand to make up to a two-thirds loss when they finally recover what is left of their money.
Adrian Lowcock, head of personal investing at Willis Owen, called the Woodford debacle ‘truly shocking’, saying, ‘We have seen the complete demise of the most famous fund manager the UK has seen for years.’
The fallout from Woodford’s fall
The Woodford saga will inevitably trigger nervousness in the investment community. The myth of the ‘super’ fund manager has again been punctured, with the most sobering reminder yet that ‘past performance is not a guide to future performance’.
The biggest surprise, however, is that anyone is surprised. By now it should be drummed into every investor that big rewards go hand-in-hand with big risks. An asset is said to be ‘volatile’ when it can deliver stellar performance some of the time, only to give abysmal returns at other times. This description applies whether you are talking about individual equities, a crypto-currency, or a whole investment fund. Woodford’s exceptional performance in the past should (perhaps counter-intuitively) have served as a red flag for his clients. This isn’t to say that they should have avoided his funds altogether; rather, that they should have treated Woodford’s products as ‘volatile assets’ and invested only as much as they could afford to lose, while spreading their portfolio across other, more stable assets.
Many did not. What’s more, many were not high-net-worth investors but ordinary individuals. One high profile case is that of Kent County Council, whose pension fund has over a quarter of a billion pounds invested in the Woodford fund. Though this sum represents less than 5 per cent of the Kent Pension Fund’s total value, and the Council insists that there will be no impact on their service provision, it is still an anxious time for scheme members. Meanwhile hundreds of thousands of other investors have been left in limbo, unsure if they can still afford the retirements they were planning.
Lessons for investors and pension savers
The Woodford debacle has wider implications for investors and pension schemes. Can they depend on such funds in the future? The answer, of course, is that they could never ‘depend’ on them. Investment funds are an invaluable tool for generating returns over time, but like many tools they can be dangerous if used carelessly.
Investors (and this includes anyone who belongs to a pension scheme, which is most UK workers) owe it to themselves to pay more attention to where and how their money is held. This means contacting workplace pension providers to ask about the funds involved, and to check that these are suitable for one’s personal risk profile. A pension fund that shows unusually erratic performance (large gains followed by heavy losses), or a fund that depends on a narrow range of assets for its gains, should raise warning flags. The same caution should apply to those drawing down an invested pension pot, not just those building one up. Judging the personal suitability of a pension fund requires expertise, however, so is usually a task for an independent financial adviser.
The moral of the story is an old one: if it looks too good to be true, it usually is. Investment experts can be as fallible as anyone – though that doesn’t mean you shouldn’t use them. As in any competitive field, stars will rise, have their day, and then (perhaps) lose their form. The private investor simply needs to remember this reality, and spread their eggs over a sufficient number of baskets.
Investment primer: what is a fund?
A fund is a way to invest in the stock market without having to choose individual stocks yourself (which can be challenging, especially for novice investors). When you invest in a fund, your money is pooled with that of other investors and used to buy up a range of different assets, including equities and bonds.
The choice, range and diversity of assets chosen will depend on the fund’s stated strategy, and/or on the fund manager’s professional judgement. Not all funds have a fund manager. ‘Passive’ funds will follow a simple strategy such as tracking a particular market in the hope of steady growth – as a result they have lower management fees. By contrast, ‘active’ funds are run by fund managers who do real-time research, and who buy and sell regularly to try and beat the average market performance. This service results in higher fees.
Which are better – active funds or passive funds?
The European Securities and Markets Authority’s (ESMA) first annual report found that active funds do outperform passive funds by a small margin – but that this margin disappears once the higher fees for active funds are factored in. Higher fees mean that, over the long term, passive funds will generally outperform active ones, on average.
There is a catch, however, which is in the words ‘on average’. Among the large number of active funds there will be some that outperform passive funds even when fees are included – just as there will be others that perform worse than passive funds. The challenge is to identify those top performers (not easy) and to use them wisely, i.e. not depending on them too heavily.
In most cases, investors should aim for a blend of active and passive funds, favouring active funds to deliver aggressive, short-term growth and passive funds for maintaining long-term stability.