What have fund managers learned about illiquid assets years after Woodford’s crash?

Fund management continues to be haunted by the ghost of Neil Woodford.

His boutique went down in 2019 leaving thousands of investors with huge losses. Many of them still await redress.

Woodford’s problems were not caused by hubris. They were caused by his open-ended Equity Income fund’s inability to liquidate assets. These companies offer enormous growth potential, but they also come with greater risk.

Investors withdrew their money as markets plummeted and his stock selections fell. Woodford was forced to sell more publicly traded stocks in order to make the redemptions. His unlisted holdings, which can be harder to sell, made up a greater portion of the fund. This spiral led to the fund being suspended, trapping investors.

What lessons have active funds managers learned? Although many companies don’t have the same level of exposure to Woodford in open-ended fund management, this investment practice has not been eliminated.

Fidelity, Allianz and others are some of the largest names that offer open-ended funds. They also have holdings in unlisted companies. Schroders and others will allow it if the company is scheduled to be listed soon.

These large fund groups have strong risk management and liquidity checks. Only a few funds hold a small amount unlisted stock. Unlisted companies may be held in open-ended funds by some groups. This suggests a lack of transparency.

The fund “supervisors”, also known as authorized corporate directors, are responsible for overseeing the fund’s liquidity profile. Woodford’s ACD Link Fund Solutions is currently in talks with the Financial Conduct Authority to recover money for investors and avoid a heavy fine.

Liquidity isn’t the only problem. Investors may feel that they don’t know the true value of unlisted assets. Private companies have their own valuation metrics that are not transparent, unlike publicly traded shares. Also, there is a disconnect between private and public markets: Global equities declined by a fifth last fiscal year, while private equity firms saw modest gains.

Some fund houses took action. Jupiter’s chief executive made a decision earlier this month that the group’s funds would not make new investments in unlisted stock. This decision came as the UK Mid-cap fund had just sold a 6 percent stake in private firm Starling. It is a digital bank.

Analysts have cautioned that investment trusts can be better suited to liquid assets than they are for liquid assets. Scottish Mortgage, one the UK’s most well-known investment trusts, saw private companies exceed its 30% threshold at the end last year.

Problematic property funds can also be problematic. Many property funds were unable to continue after the 2016 Brexit vote. Investors worried about their investments’ valuations rushed out to get out of their investments. Funds were then forced to “gate” temporarily, trapping investors within the fund. This same problem occurred in 2020 when the pandemic hit, and again last year after the “mini” Budget.

Open-ended property fund providers have closed their doors, citing liquidity management concerns. Others, like the US and Japan tend to choose closed-ended trust structures for real estate.

The Financial Conduct Authority in the UK proposed rules to protect investors in the UK’s property sector. They suggested that they provide a notice period for redemption so funds can sell their property investments. The changes have not been finalized, however.

The FCA stated last week that it was also considering the rules regarding liquidity management in the asset management industry.

The issue has been a problem for regulators for a long time. Mark Carney, the former Governor of Bank of England, stated in 2019 that funds that invest in illiquid assets, which allowed investors to withdraw their money at any time, were “built on lies”.

He said that even though there is liquidity mismatch, these funds pretend to be ATMs. Woodford reminded us all that this act can quickly crumble.