From Ros Altmann:economist and pensions,
    investment and retirement policy expert

  • pensionsandsavings.com

    Implications of the Woodford debacle

    Implications of the Woodford debacle

    • Woodford Funds collapse highlights inadequate protections for ordinary investors.
    •  Regulatory actions too little too late – funds with rising risks, falling liquidity and daily pricing need more timely intervention.  
    • Clear warning signs in 2017 – Guernsey ‘listing’ for illiquid holdings was obvious red flag.   
    • Does FCA have adequate powers to suspend management charges or penalise managers?   
    • Loss of confidence in retail fund management industry may increase use of lower cost passive funds.   

    Inadequate protections for ordinary investors: The events surrounding the failure of the Woodford retail funds highlights the inadequacy of protection for retail investors. Many people rely on the fund management industry to look after their money, hoping for good long-term returns. They pay management fees to ‘experts’ to select investments on their behalf and obtain a broader spread of holdings to mitigate stock-specific risks. Most retail investors are not experienced in money management, so they need a system of regulation to protect them against potential mis-management by the professional firms who might otherwise take advantage of the asymmetry of knowledge.


    Regulator seems to have been asleep at the wheel: The FCA financial services regulator does not seem to have recognised the dangers to retail investors that were building up in the Woodford funds. It may not have been focussing on the right issues, but it also lacks sufficient power to impose punitive penalties, reduce management fees, or require better consumer protections.


    There were clear warning signs in 2017 when Woodford moved illiquid holdings into an offshore quoted entity: Woodford Funds poor performance led to large redemptions, which necessitated selling the more marketable holdings. So the proportion of illiquid investments increased beyond permitted levels in 2017. Rather than challenging the managers, the Regulator seems to have allowed unquoted holdings to be moved into an offshore ‘quoted’ vehicle, thus masking the risks that had been building for investors. This obvious red flag should have immediately generated a regulatory intervention.


    As the risks were rising, Regulator seems to have ignored risks to ordinary investors: The Woodford Funds were becoming increasingly risky and illiquid, yet the Regulator failed to alert the market, leaving ordinary investors in the dark. These funds were not reclassified as high risk, there were no warnings and no liquidity requirements that may have helped more investors avoid large losses. Insufficient attention was given to the interests of ordinary investors, who were trusting that they could withdraw their money if they needed to.


    Investors would like to see FCA having powers to order reduced charges when a Fund suspends trading: Once the Woodford Funds suspended trading, investors still had to pay full fees to the managers. Most investors feel this adds insult to their injury, as they are forced to pay a manager who has locked up their money without warning.


    Damaged confidence in the retail fund management industry may encourage more retail investors to abandon active managers: Consumers have been willing to pay for ‘star’ managers and top firms to look after their money. However, the lack of regulatory protection that has been highlighted in the Woodford case may well knock confidence in all active managers. Many retail investors could decide to switch to cheaper passive funds. Others might give up on investing and just use cash savings, which is likely to reduce their long-term returns.


    Regulator should do more to protect investors and maintain confidence in the system: Of course, long-term investors should not normally be expecting to trade their holdings actively, but if a fund has daily liquidity then Regulators need to ensure the underlying holdings are managed appropriately. Government should urgently consider whether the FCA needs more powers to prevent this type of mis-management and how to monitor funds which offer daily pricing, but are holding illiquid assets. And if this does not happen, there should be punitive penalties for managers. Consumers need to be confident that the Regulator is looking out for risks that could result in significant losses. Ignoring clear warning signs for two years, culminating in suspension of trading and then failure, is a serious concern for the whole industry.


    Long-term investors and pension funds may not need daily pricing: Pension investors use retail funds and it is important they understand the risks. Most investors cannot manage their own portfolios and need to rely on the fund management firms. However, they also need to be properly informed about the risks and realities. There are proposals to increase pension holdings in venture capital, infrastructure and other less liquid investments, which makes sense for long-term investors, as it can improve the risk-return characteristics of a pension portfolio. But such holdings do not seem compatible with expectations of daily pricing. Perhaps the industry and Regulators need to consider whether daily pricing is really necessary or appropriate for long-term pension investing. Monthly or less frequent trading would allow managers to include a wider range of assets to improve long-term returns, especially in light of the exceptionally low interest rate environment.

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