The Woodford Equity Income Fund ("WEIF") was placed into liquidation in October 2019, after having suspended redemptions in June. The fund had been managed since its 2014 inception by Neil Woodford, an investment manager widely credited with "star" status following a successful career in the City. Fast-forward five years and Woodford's funds are in wind-down, Woodford is removed as the manager, and his reputation is in ruins.
In the first part of this two-part blog, we looked at how Woodford's failure came about and asked how the FCA could have allowed it to happen. In this, the second part, we offer some further reflections on this saga and its implications for the future of UCITs for investors. We start with a consideration of the role of the regulator.
The Bigger Regulatory Picture. The FCA's omissions and its basic failure to accord WEIF investors with the sort of basic protections that they believed (or were told by IFAs and other middlemen) they would be afforded by the UCITs product is symptomatic of the attitude of European financial regulators to the UCITs model. The genesis of UCITs was as a liquid investment product, highly regulated and regarded as "safe" for investment by small, retail investors. But for more than a decade the UCITs envelope has been pushed by EU states and regulators to allow managers more and more able to replicate, sometimes in a synthetic way, riskier investment techniques traditionally available only to managers of hedge funds. Under UCITs rules, Illiquid investments have a very circumscribed place in the fund's portfolio, but increasingly financial regulators in Luxembourg have permitted the shoehorning of illiquid assets into UCITS and UCITs wrappers. The FCA, keen for London as a centre of asset management to keep step with Luxembourg, has followed suit and has played its part in the significant divergence of the current iteration of the UCITs model from the original incarnation. See my blog, "UCITs and Hedge Funds: Not a Match Made in Heaven" for a more detailed treatment of this point.
One positive outcome of the Woodford saga would be a wholesale revision by regulators, including the FCA, of the UCITs rules and an attendant evaluation of the risk analysis that ought to be applied to a series of model UCITs portfolios and investment strategies within the parameters and constraints of the current UCITs rules. The fact of the matter is that the things some managers are allowed to do (or not do) with UCITs - like Woodford and the WEIF - materially shift the position on any objective risk spectrum of this supposedly safe, regulated, retail investment product.
Non-UCITS to the Rescue? Some commentary in the immediate aftermath of the closure of WEIF has asked whether the standard disclosures in a fund's prospectus - such as those pertaining to the circumstances in which redemptions may be suspended - go far enough to ensure that investors are sufficiently informed before investing. Other commentators have asked whether the daily liquidity posited by the UCITs model should be subjected to some sort of qualification.
Our view is that the answer to the problems highlighted by the Woodford story may be found in the non-UCITs (NURs) regime. These illiquid or semi-liquid investment funds have traditionally mainly been used for real estate portfolios, but the regulatory framework is capable of revision and expansion to accommodate investors with the appetite and risk tolerance for some - intentional - illiquidity in a fund's portfolio, and who understands the liquidity profile of his shares, which may be redeemable monthly or quarterly, as opposed to daily.
Had the NURs model been sufficiently evolved in this regard from the version that was available to Neil Woodford back in 2014, when he had his illiquid investments in mind, the fund product duly structured and sold to investors would have been a lot better suited to his investment style and strategy than the (supposedly) liquid UCITs that WEIF ended up being. In this sense, then, the UK's investment fund regime, and its legal and regulatory parameters failed both Woodford and his investors.
UCITs and the Myth of Active Management. Neil Woodford came under very heavy criticism for not waiving or suspending his asset-based management fee during the time that redemptions in WEIF were suspended, from June 2019 until his removal as a manager in October 2019. Investors asked, "if the value of our shares in WEIF is diminishing by the day, because of investment decisions and other faults on the part of the manager, and our ability to redeem out of the fund is being blocked, why should we still be liable to pay the manager his fee on the assets remaining in the fund?". It was a good, and fair question, one which widely resonated across not just the asset management industry but in mainstream and social media as well. It was a question that led to the fatal ebbing of whatever diminished confidence investors and the industry had left in Neil Woodford. It was a question that, in its being left too long unanswered by him, led ultimately to the administrator stepping in and relieving him of his management mandate.
Woodford's failure - or refusal - to waive his asset-based fees, and to refund fees previously taken, while WEIF tanked and his investors' savings remained trapped inside, was seen by many as redolent of the "because I'm worth it" attitude displayed by many "star" fund managers. The existence of this mentality in the asset management industry is incontrovertible, although its extent and the role it plays in how funds are managed by individual managers is debatable. This mindset is, more fundamentally, a component of a common misconception about retail funds like UCITs (and WEIF), one that managers and investment advisers are scarcely keen to debunk: that these investment products are "actively" managed. They are not.
Active management is a non-passive form of management, which by definition goes beyond passive tracking of indices and embraces active, alpha-generating techniques such as short, use of sophisticated financial instruments, and dynamic use of leverage. The point of active management is that, by generating returns that are uncorrelated to markets, it produces profits for investors even in down-markets. This is traditionally the realm of the hedge fund and the correspondingly high fees that hedge fund managers charge their investors.
In retail funds like UCITs, no shorting or dynamic use of leverage is permitted. Managers of UCITs in effect are mandated to place long-only bets on liquid (safe-ish) stocks. This is not active management in its true sense. True that Woodford's strategy for WEIF was not passive index-tracking. But nor was it hedge fund-style, active management; he was too constrained by the retail-friendly UCITs regime for that. This fact did not, however, prevent him and other investment professionals from heavily promoting his "active" management as being worth a premium. It wasn't.
Hargreaves Lansdowne and the Role of the Middlemen. Enter at this point Hargreaves Lansdowne ("HL"), a platform promoter of investment funds. Neil Woodford featured regularly in HL's "Top Fifty" list of the "best" fund managers. This "best-buys" selling technique came under heavy criticism following Woodford's removal by the administrator of WEIF, particularly after it emerged that HL had continued to promote Woodford, his ability and his funds following the suspension of redemptions in WEIF.
Woodford and his right-hand man took around £100 million in fees from WEIF since its inception in 2014. Clearly, HL would have received a healthy percentage of this revenue in return for promoting WEIF in what is now seen to have been manifestly an inappropriate manner. Retail investors were fed a large amount of compellingly -hyped sales puff. There is now anger at HL's close commercial alignment with Woodford, and their apparent complicity in the taking of money from vulnerable retail investors. The reality of HL's involvement in WEIF is quite probably somewhat less sinister than some critics at the time of writing are keen to suggest, but there is nonetheless a morally compelling case for HL to be encouraged (some would say legally obliged, if required) not to hide behind the defensive mantras of "Caveat Emptor" or "Investors Capital is Always at Risk".It also seems likely that the role of platforms like HL will be susceptible to future review by the FCA. But investors would be wise not to hold their breath.
The Woodford Saga: Lessons to be Learned? The shoehorning of non-retail type assets and investment techniques into a retail envelope like UCITs was a trend that was apparent as early as 2008 and which we warned about in our blog from that time (see "UCITs and Hedge Funds: Not a Match Made in Heaven"). To some extent, a UCITs blow-up like Woodford was an accident that has been waiting to happen for some time.
The story of Woodford and the experiences of all Woodford stakeholders will hold some upside, some of which we have suggested here, like the tightening of the retail-friendly protections of the UCITs model, the expansion of the NURs regime to suit managers and investors alike, and the regulation of middlemen like Hargreaves Lansdowne. Whatever lessons industry professionals - including fund managers - may learn from Woodford, it will be duly-chastened investors who will be doing the teaching, having learned, the hard way, a three-fold truth: (i) you can never believe the hype about a fund manager, (ii) your capital is always at risk in an investment fund, and (iii) if you cannot afford the risk of losing that capital, DO NOT INVEST!
ABOUT THE AUTHOR
Matthew Feargrieve is an investment funds lawyer with more than twenty years' experience of advising managers of investment funds operating in the leading jurisdictions of the United Kingdom, Luxembourg, Ireland, and the Cayman Islands.
In the first part of this two-part blog, we looked at how Woodford's failure came about and asked how the FCA could have allowed it to happen. In this, the second part, we offer some further reflections on this saga and its implications for the future of UCITs for investors. We start with a consideration of the role of the regulator.
The Bigger Regulatory Picture. The FCA's omissions and its basic failure to accord WEIF investors with the sort of basic protections that they believed (or were told by IFAs and other middlemen) they would be afforded by the UCITs product is symptomatic of the attitude of European financial regulators to the UCITs model. The genesis of UCITs was as a liquid investment product, highly regulated and regarded as "safe" for investment by small, retail investors. But for more than a decade the UCITs envelope has been pushed by EU states and regulators to allow managers more and more able to replicate, sometimes in a synthetic way, riskier investment techniques traditionally available only to managers of hedge funds. Under UCITs rules, Illiquid investments have a very circumscribed place in the fund's portfolio, but increasingly financial regulators in Luxembourg have permitted the shoehorning of illiquid assets into UCITS and UCITs wrappers. The FCA, keen for London as a centre of asset management to keep step with Luxembourg, has followed suit and has played its part in the significant divergence of the current iteration of the UCITs model from the original incarnation. See my blog, "UCITs and Hedge Funds: Not a Match Made in Heaven" for a more detailed treatment of this point.
Non-UCITS to the Rescue? Some commentary in the immediate aftermath of the closure of WEIF has asked whether the standard disclosures in a fund's prospectus - such as those pertaining to the circumstances in which redemptions may be suspended - go far enough to ensure that investors are sufficiently informed before investing. Other commentators have asked whether the daily liquidity posited by the UCITs model should be subjected to some sort of qualification.
Our view is that the answer to the problems highlighted by the Woodford story may be found in the non-UCITs (NURs) regime. These illiquid or semi-liquid investment funds have traditionally mainly been used for real estate portfolios, but the regulatory framework is capable of revision and expansion to accommodate investors with the appetite and risk tolerance for some - intentional - illiquidity in a fund's portfolio, and who understands the liquidity profile of his shares, which may be redeemable monthly or quarterly, as opposed to daily.
Had the NURs model been sufficiently evolved in this regard from the version that was available to Neil Woodford back in 2014, when he had his illiquid investments in mind, the fund product duly structured and sold to investors would have been a lot better suited to his investment style and strategy than the (supposedly) liquid UCITs that WEIF ended up being. In this sense, then, the UK's investment fund regime, and its legal and regulatory parameters failed both Woodford and his investors.
UCITs and the Myth of Active Management. Neil Woodford came under very heavy criticism for not waiving or suspending his asset-based management fee during the time that redemptions in WEIF were suspended, from June 2019 until his removal as a manager in October 2019. Investors asked, "if the value of our shares in WEIF is diminishing by the day, because of investment decisions and other faults on the part of the manager, and our ability to redeem out of the fund is being blocked, why should we still be liable to pay the manager his fee on the assets remaining in the fund?". It was a good, and fair question, one which widely resonated across not just the asset management industry but in mainstream and social media as well. It was a question that led to the fatal ebbing of whatever diminished confidence investors and the industry had left in Neil Woodford. It was a question that, in its being left too long unanswered by him, led ultimately to the administrator stepping in and relieving him of his management mandate.
Woodford's failure - or refusal - to waive his asset-based fees, and to refund fees previously taken, while WEIF tanked and his investors' savings remained trapped inside, was seen by many as redolent of the "because I'm worth it" attitude displayed by many "star" fund managers. The existence of this mentality in the asset management industry is incontrovertible, although its extent and the role it plays in how funds are managed by individual managers is debatable. This mindset is, more fundamentally, a component of a common misconception about retail funds like UCITs (and WEIF), one that managers and investment advisers are scarcely keen to debunk: that these investment products are "actively" managed. They are not.
Active management is a non-passive form of management, which by definition goes beyond passive tracking of indices and embraces active, alpha-generating techniques such as short, use of sophisticated financial instruments, and dynamic use of leverage. The point of active management is that, by generating returns that are uncorrelated to markets, it produces profits for investors even in down-markets. This is traditionally the realm of the hedge fund and the correspondingly high fees that hedge fund managers charge their investors.
In retail funds like UCITs, no shorting or dynamic use of leverage is permitted. Managers of UCITs in effect are mandated to place long-only bets on liquid (safe-ish) stocks. This is not active management in its true sense. True that Woodford's strategy for WEIF was not passive index-tracking. But nor was it hedge fund-style, active management; he was too constrained by the retail-friendly UCITs regime for that. This fact did not, however, prevent him and other investment professionals from heavily promoting his "active" management as being worth a premium. It wasn't.
Hargreaves Lansdowne and the Role of the Middlemen. Enter at this point Hargreaves Lansdowne ("HL"), a platform promoter of investment funds. Neil Woodford featured regularly in HL's "Top Fifty" list of the "best" fund managers. This "best-buys" selling technique came under heavy criticism following Woodford's removal by the administrator of WEIF, particularly after it emerged that HL had continued to promote Woodford, his ability and his funds following the suspension of redemptions in WEIF.
Woodford and his right-hand man took around £100 million in fees from WEIF since its inception in 2014. Clearly, HL would have received a healthy percentage of this revenue in return for promoting WEIF in what is now seen to have been manifestly an inappropriate manner. Retail investors were fed a large amount of compellingly -hyped sales puff. There is now anger at HL's close commercial alignment with Woodford, and their apparent complicity in the taking of money from vulnerable retail investors. The reality of HL's involvement in WEIF is quite probably somewhat less sinister than some critics at the time of writing are keen to suggest, but there is nonetheless a morally compelling case for HL to be encouraged (some would say legally obliged, if required) not to hide behind the defensive mantras of "Caveat Emptor" or "Investors Capital is Always at Risk".It also seems likely that the role of platforms like HL will be susceptible to future review by the FCA. But investors would be wise not to hold their breath.
The Woodford Saga: Lessons to be Learned? The shoehorning of non-retail type assets and investment techniques into a retail envelope like UCITs was a trend that was apparent as early as 2008 and which we warned about in our blog from that time (see "UCITs and Hedge Funds: Not a Match Made in Heaven"). To some extent, a UCITs blow-up like Woodford was an accident that has been waiting to happen for some time.
The story of Woodford and the experiences of all Woodford stakeholders will hold some upside, some of which we have suggested here, like the tightening of the retail-friendly protections of the UCITs model, the expansion of the NURs regime to suit managers and investors alike, and the regulation of middlemen like Hargreaves Lansdowne. Whatever lessons industry professionals - including fund managers - may learn from Woodford, it will be duly-chastened investors who will be doing the teaching, having learned, the hard way, a three-fold truth: (i) you can never believe the hype about a fund manager, (ii) your capital is always at risk in an investment fund, and (iii) if you cannot afford the risk of losing that capital, DO NOT INVEST!
ABOUT THE AUTHOR
Matthew Feargrieve is an investment funds lawyer with more than twenty years' experience of advising managers of investment funds operating in the leading jurisdictions of the United Kingdom, Luxembourg, Ireland, and the Cayman Islands.
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