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Woodford wobbles

Why has the Woodford Equity Income fund failed?

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Justin Modray
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You’ll no doubt have read by now that Neil Woodford’s flagship Equity Income fund has closed its doors to investors buying and selling the fund, for an initial period of 28 days.

The suspension, resulting from an increasing number of investors heading for the door, is necessary to prevent the untradeable portion of Woodford’s portfolio (so called ‘unquoted securities’) rising above the allowed 10% of fund value.

This is a dire situation to which I’m struggling to see a happy ending.

There are two key drivers behind the fund’s downturn in fortune: poor stock picking by manager Neil Woodford and his penchant for investing in small, privately owned companies.

Woodford favourites including Provident Financial, Purple Bricks, The AA and Kier Group have seen their share prices collapse over the last couple of years, hurting fund performance and casting serious doubts over Woodford’s stock picking rationale. This prompted many investors to withdraw money and invest elsewhere (as we recommended our clients to do last year), causing the fund to shrink significantly.

A shrinking fund shouldn’t necessarily pose a problem, but Woodford has come unstuck from investing some of his fund in the shares of privately-owned companies (unquoted securities) that can’t be readily traded. As investors withdrew cash, Woodford had to sell other more easily traded stocks, meaning the proportion of the fund invested in unquoted securities soared.

Rules prevent more than 10% of Woodford’s fund being held in unquoted securities, so back in March he largely fudged the issue by swapping unquoted securities in his Equity Income fund for shares in his Patient Capital investment trust (which is listed in the stock exchange). However, continued heavy withdrawals appear to have pushed that approach to the limit, so when Kent Council requested a £238 million withdrawal on Monday, it was the straw that broke the camel’s back prompting the fund’s subsequent suspension.

The initial suspension is for 28 days, but I don’t see it ending soon, or well. The only practical solution is for Woodford to sell his unquoted securities before re-opening the fund. Investors are no doubt spooked by recent events, so when the fund does re-open there will likely be heavy withdrawals. If the unquoted securities issue is not fully resolved, which may take some time, it could quickly bite back leading to a further suspension.

Since there is no formal market for unquoted securities, Woodford will have to find other investors to take these off his hands and, as a forced seller, it’s unlikely he’ll achieve top dollar. If he sells below the price at which his fund currently values them, then expect a further fall in the Equity Income fund value, adding to investors’ woes. There’s certainly now a question mark over the fund’s longevity, which will depend on the extent remaining investors withdraw cash when able to do so.

It’s a sorry state of affairs that I doubt anyone predicted when Woodford launched the fund via his new firm in June 2014, after a long, celebrated career at Invesco Perpetual.

Hargraves Lansdown, arguably the fund’s biggest supporter, continued promoting Woodford Equity Income via its ‘Wealth 50’ fund list right up until the suspension, and still holds around £620 million of the fund within its own multi manager fund range. I expect affected Hargreaves’ customers will be questioning the firm’s motives and judgement for doing so. It certainly doesn’t paint Hargreaves Lansdown Research Director Mark Dampier, an ardent defender of Woodford, in a good light.

I expect the backlash and recriminations surrounding Woodford will drag on for weeks, if not months. Meanwhile, it’s a very timely reminder that, no matter how much confidence you might have in a manager, always keep exposure to sensible level. Even the mightiest can fall.

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