A post-mortem by British lawmakers and regulators into the suspension of the U.K.’s best known stockpicker’s flagship fund could expose some systemic flaws in the fund industry, analysts have suggested.
Conservative Member of Parliament (MP) Nicky Morgan, chair of the Treasury Committee, last week wrote to the CEO of Britain’s most influential investment platform, FTSE 100-listed Hargreaves Lansdown (HL), to request information about its “close link” with high profile manager Neil Woodford.
Neil Woodford, Woodford Investment Management.
Woodford Investment Management
HL kept Woodford’s ailing Equity Income Fund on its Wealth 50, a list of recommended investments for retail clients, from its inception in 2014 until it was forced to suspend trading earlier this month. This was despite its value reducing from £10.2 billion ($12.8 billion) to £3.7 billion over the course of two years, following a string of bad stock calls and investor withdrawals.
In a response to Morgan published Wednesday, HL CEO Chris Hill documented the stockbroker’s efforts to exert pressure on Woodford to reduce the percentage of illiquid holdings in the fund.
Hill also revealed that HL only learned on Tuesday, upon reading a letter to the Treasury Committee from Andrew Bailey, chief executive of the U.K.’s Financial Conduct Authority (FCA), that the Woodford Equity Income fund twice breached the regulator’s 10% limit on the maximum proportion of unlisted securities held.
Hill’s letter claimed that HL first confronted Woodford over the rising proportion of private and illiquid stocks in his portfolio in late 2017, and had “insisted” that Woodford not breach the 10% level “and to inform us immediately if they did, to which they also agreed.”
“They did not inform us of this on either occasion,” Hill added. “In January 2018 we initiated monthly communications with Woodford Investment Management specifically addressing the unquoted stocks in the portfolio, either via a call or email.”
However, a Woodford spokesperson disputed this, telling CNBC Wednesday that the agreement with HL was to “inform them of any month-end breaches only.”
“Consistent with all clients, Woodford provided month-end data for investors and at no time was there a month-end passive breach,” the spokesperson said.
“The FCA reference to breaches in February and March 2018, relates to two inadvertent intra month passive breaches, both resolved before month-end.”
Hill said HL has tried to discuss the valuation of the fund’s individual private and illiquid investments and the timing of its reopening with the authorized manager, Link Fund Solutions, but has received no response.
HL has since waived its platform administration fees for clients with holdings in the Woodford Equity Income fund, and urged Woodford to do the same, but thus far he has refused.
FCA launches formal investigation into Woodford
Bailey’s letter Tuesday confirmed that the FCA has launched a formal investigation into the events leading up to the suspension of trading in the Woodford fund.
Bailey said the regulator had been in regular contact with the Woodford Equity Income fund’s authorized manager, Link Fund Solutions, between April and December 2018 to discuss the fund’s “deteriorating liquidity position.”
The Woodford spokesperson said: “We can confirm we have been contacted by the FCA, regarding its investigation relating to the events that led to the suspension of the LF Woodford Equity Income Fund, and will be co-operating fully with its investigation.”
Bailey and FCA Chairman Charles Randell are due to give evidence before the Treasury Committee next week. In a statement Tuesday, Morgan said: “The Committee will examine this letter and wider issues brought into focus by the suspension of the Woodford Fund when we take evidence from Mr Bailey and Mr Randell next week.”
Hill revealed that in total, 291,520 HL clients were either directly or indirectly exposed to the embattled Woodford fund, collectively owning units with £1.62 billion ($2.05 billion).
The broker’s income from client fees in respect to the Woodford fund was £7.4 million in 2018, and a total of over £40 million since it first listed.
Hill stressed in the letter to Morgan that HL does not retain any of the commission on the fund, in accordance with the FCA’s platform charging rules, and any payment received is “passed to the client in the form of a loyalty bonus.”
HL’s income derives from a platform fee charged directly to clients on the value of their investments in the fund, proportionate to their overall holdings. As such, it earns the same fee regardless of the funds they hold.
Hill highlighted that while a fund’s presence on its Wealth 50 list does drive higher inflows toward it, investors “benefited by £61 million in discounted fees as a result of the terms we have negotiated with fund groups.”
He added that the Wealth 50, and its predecessor Wealth 150, have on average outperformed the relevant benchmark index and sector average after charges, by 5.8% and 11.8% respectively since inception.
HL’s support for Woodford has been a major factor in the massive sums he was able to raise in the Equity Income Fund, and commentators have indicated that this case raises broader questions about the value and transparency the fund industry offers to everyday retail investors.
The scrutiny by both lawmakers and regulators of the long-standing harmony between the U.K.’s biggest stockbroking platform and its most high-profile fund manager could air some long-standing systemic questions around what retail investors who access active funds through investment platforms are getting for their money.
Andy Agathangelou, founding chair of the multinational Transparency Task Force, told CNBC that “this particular case is indicative of the issues within the financial services sector that come up time and time again around lack of transparency, costs and charges.”
Clara Durodie, chair of an advisory and investment firm called the Cognitive Finance Group, said HL “control the influence in the market,” meaning retail investors and financial advisors often do not see fit to perform their own due diligence when a fund is featured on its recommended list.
“Deploying artificial intelligence tools which would improve reporting and transparency should be the only way forward,” Durodie told CNBC.
Alpesh Patel, founder of private equity house Praefinium Partners, told CNBC that name recognition and a perceived “hot hand” mean certain fund managers attract the most client money, regardless of whether or not they outperform an index tracker after fees are deducted.
Patel said “best buy” lists across the industry were “a great little business, because you’re getting paid regardless of the fund’s performance,” but argued that retail investors should be directed toward index trackers rather than active fund managers.
HL defended its methodology for selecting funds at length in its response to the Treasury Committee, highlighting that its investment research team spends “thousands of working hours every year” on quantitative and qualitative analysis, along with conducting 175 fund manager meetings a year. Investment decisions are also ratified by an independent committee.
Hill’s defense for retaining the fund was that Woodford’s contrarian stockpicking style meant he has historically underperformed for long periods before staging lengthy rallies, leading HL’s analysts to conclude that this situation would play out in a similar fashion.
Woodford’s major breakthrough came when he avoided the dotcom bubble during a hugely successful spell at Invesco Perpetual, where his track record first catapulted him to fame.
A recent Numis note offered a “buy” recommendation for HL’s stock on the basis that the company has grown from £800 million of assets under management in 2001 to £97.8 billion today, and now holds a 4% share of the circa £2.4 trillion U.K. savings market.
This means when HL recommends a fund, the average retail investors and pension funds that comprise its client base tend to listen and flock to it in droves.
Responding to the letter from Bailey on Tuesday, Morgan said “the Committee will examine this letter and wider issues brought into focus by the suspension of the Woodford Fund when we take evidence from Mr Bailey and Mr Randell next week.”
Suddenly, the methodology that has garnered such a substantial market share and growth story is under the spotlight, along with all conventional wisdom on the culture of “star fund managers” and trust in the fund industry as a whole.