Woodford Equity Income Fund; People are missing the point!

As DIY Investor’s Christian Leeming digs deeper into the Woodford scandal, it only gets to look uglier. UCITS funds should be some of the most tightly regulated in the world, but he says what he finds looks more like a Ponzi scheme.

‘Firstly, it is obvious that this story is set to rumble on for months and everyone has an opinion, lets us therefore consider three of this week’s opinions:

• Research from MSCI reveals the illiquid profile of the fund was much worse than the number of unlisted securities suggested. It also had a substantial weighting to illiquid stocks that were listed on regulated exchanges. This mishmash mean that both quoted and unquoted – made up almost 50% of the fund’s portfolio at the end of January 2018. By the end of last year, that had shot up to almost 85% as Woodford offloaded his most liquid holdings in order to meet redemptions.MSCI defines these illiquid listed securities as those outside the MSCI ACWI IMI, which aims to represent the investable    equity opportunity set for large-, mid- and small-cap securities listed in developed and emerging markets.A spokesperson for Woodford told Investment Week MSCI’s research was ‘based on a theoretical model and the reality in the market is rather different’. The spokesperson added: ‘To define stocks that trade millions of pounds a day as illiquid illustrates the constraints in the model. Time Out is a recent example of a holding that was estimated to take over 50 days to sell, yet we sold the full position within a day, at the market traded price. There are many similar examples where the liquidity models of MSCI are wrong. This year alone, WEIF has sold almost £700m of stock across the holdings the MSCI says are illiquid.’

• Financial Conduct Authority Chairman Charles Randell explained that Woodford Investment Management’s use of the so-called ‘10%’ rule for illiquid stocks, combined with other aspects of the regime, had led to the gating.Randell said: ‘If you have a series of underperformance in the quoted part of the portfolio with fairly static valuations in the unlisted part, you will quickly start hitting that 10% buffer.It is the [UCITS] daily redemption [and] illiquidity [rules], coupled with the 10% rule that has created the perfect storm in the case of the Woodford fund.’

• And the Bank of England Governor Mark Carney and deputy Jon Cunliffe were questioned on the implications of the suspension of Neil Woodford’s flagship fund during an appearance before the Treasury committee this morning.

While Carney did not refer to Woodford’s fund directly, he said funds that offered daily redemptions while holding illiquid assets were ‘built on a lie’.

Other than the date, the only truism here is Mark Carneys statement, funds that offered daily redemptions while holding illiquid assets were ‘built on a lie’. He is being polite, it’s a whopper of a lie.

And, at the risk of repetition, if there is no immediate market how can the fund be priced accurately? Everyone has ignored this, but it throws up some very interesting points:

• All the portfolio valuations going back to inception are questionable.
• People therefore may have invested at the wrong price meaning they have too many/too few shares
• Were any of the redemptions made at the right price? Perhaps, some people have been paid too much
• If point 3 is correct, then then first ones grabbing the cash have benefitted at the expense of people still invested.

Despite everything, no one is addressing the key point; the manager sought to game the UCITS rules and was holding assets in a way that appeared to be within the directive. This isn’t financial engineering it is a deliberate action to break the rules.

In addition, this is the second time the self-same trick has been pulled, Arch Cru being the first. To be caught once is bad enough, to be caught a second time is criminal.

Were the ACD and FCA asleep at the wheel? Or, were they blinded by the dazzle of Neil Woodford? Either way this is the big question and heads should roll.

The implications of this fund should be and, we have to hope, will be far reaching. As this column highlights if there is no liquidity there is no way of establishing a price.

Investors that have already sold their shares could have benefitted at the expense of those less nimble; UCITS funds are meant to be some of the most highly regulated fund structures in the world, suitable for the least informed investors who, quite correctly, expects protection from these robust rules and the rigid enforcement of them by authorised parties and vigilant regulators.

That clearly is not the situation here, instead what we have rather more resembles a Ponzi fund