Lessons learned from the Woodford funds debacle

21 June 2019

If you hadn’t heard of Neil Woodford before, chances are the media storm of the last couple of weeks will mean you have definitely done so by now.

Earlier this month his eponymous Woodford Investment Management sent shockwaves through the fund management sector when it announced the suspension of the £3.7bn (€4.2bn) fund following an increased level of redemptions. This has left investors unable to access their money for a 28-day period, or maybe even longer.

It would be easy to point the finger at former high-flying fund manager Neil Woodford. He allowed a personality cult to develop around him, especially after he went solo in 2014. And he lost his Midas touch, increasingly investing in things he had little or no experience with.

His reputation as a star fund manager is damaged and is unlikely to recover. The short-term nature and coverage of active investment doesn’t take any prisoners, but it also means that for those who can generate some good returns can quickly get back into favour. Although it will take something extraordinary for Woodford on this occasion.

But this is a salutary tale for all of us, not just Mr Woodford. The whole affair is an object lesson in the risks of non-advised investing. Here are some hard lessons learned.

Only buy what you understand

This is the guiding principle of the Warren Buffett school of investment. Buy blue-chips and brand names you know. 

Anything else, avoid.

Ironically, it was this very approach which made Mr Woodford’s fame and fortune in the first place. He eschewed fashionable technology stocks at the height of the dot-com boom, sticking with out-of-favour FTSE-100, dividend-rich  blue chips (the stock of a large, well-established and financially sound company that has operated for many years) instead. He was proved right.

But at some point, Mr Woodford himself began dabbling in start-ups that are not listed on any recognised stock exchange.

The risks of this are now obvious for all to see. People failed to pay attention to what was actually happening until it became too late.

So, always make sure you know what it is you are buying. If ever there is anything you don’t understand, be sure to ask the questions and get the answers. And remember, everything reverts to the mean – a star fund manager’s luck or success will eventually run out. You can’t beat the combined wisdom of all market participants consistently over time.

Or, as Mr Woodford and his followers are finding out, the market can stay irrational longer than you can stay solvent.

Know the difference between best-buy tables and actual advice

This could perhaps be the biggest takeaway from these events. Mr Woodford was a firm favourite of fund ‘best buy’ lists, chief among which are those of the various investment platforms. In particular, Hargreaves Lansdown, one of the most influential financial intermediaries, have received major criticism since the fund’s suspension for this reason.

To give Hargreaves Lansdown credit, they have always taken a long-term view with Mr Woodford, promoting him for his ability to deliver over time. But even a broken watch is right twice a day. Increasing level of redemptions showed investors’ patience with Mr Woodford was wearing thin.

The bigger question here is the responsibility on these ‘best buy’ lists. People take these as the basis for making their own investment decisions without any protection or recourse when they go wrong.

With this level of influence, it is clear that intervention of these lists is needed. It needs to be made much clearer that investors using these platforms are really on their own. Hopefully this is where the FCA is looking.

The reality for Hargreaves Lansdown customers in Mr Woodford is that, despite it appearing in its Wealth 50 and launched with a huge fanfare, there is nowhere to go if they believe they have been mis sold.

Understanding the term ‘liquidity’

Liquidity refers to how easy, or difficult, it is to buy/sell certain assets. Shares in companies listed on the stock market are bought and sold every day – these are call ‘liquid’. Start-ups or privately-owned companies with fewer shares traded and not listed in regular exchanges are referred to as ‘illiquid’.

Mr Woodford’s fund suspension has reopened debate over a fundamental flaw with so-called  open-ended funds that invest in illiquid assets. These funds offer investors the ability to buy and sell on a daily basis — but their fund managers cannot do the same with the assets they hold, such as property or early-stage companies.

There is the argument that a crackdown is needed on open-ended funds investing in illiquid assets. However, it does allow customers to invest in a diversity of fund options so perhaps it is instead a case of just adjusting the frequency of dealing in these assets.

Importance of diversification of funds

The whole point of investing in a fund in the first place is to diversify risk, rather than put all your eggs in one basket. However, some funds are more diversified than others.

A broad-based portfolio that invests in different asset classes, industries and markets across the world reduces risk compared to buying a specialist fund or individual stocks and shares.

While it will be worrying and frustrating for investors who cannot access their money in Woodford’s funds, hopefully other investments have performed better.

Keep fees low

Finally, keep costs to a minimum. Spread your risk. Buy and hold for the long term. Unless you are confident and well-read on the world of investments, don’t try to beat the market. Buy low-cost tracker funds.

Above all, ignore the cult of the star fund manager and their just-as-highly-paid promoters.

Do this, and your overall investment returns might thank you for it.

Anthony Morrow is chief executive and co-founder at OpenMoney

Anthony's views are his own and do not constitute financial advice or the opinion of Moneywise