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Bonfire of Woodford’s Vanities May Burn More Funds

Bonfire of Woodford’s Vanities May Burn More Funds

(Bloomberg Opinion) -- Rearrange the words “after the horse has bolted” and “closing the stable door” to describe the likely response from regulators to Neil Woodford’s decision to freeze his flagship equity fund last week. As the repercussions ripple through the industry, there is a risk that British rule makers will overreact to the debacle. That would be a mistake.

To summarize: On June 3, Woodford’s firm stopped clients from exiting the LF Woodford Equity Income Fund as a flood of withdrawals threatened to force it to hold fire sales of its liquid assets. In turn, that would have put the vehicle at risk of breaching the 10 percent limit on the proportion of its assets that can be allocated to unlisted securities.

Bonfire of Woodford’s Vanities May Burn More Funds

The Internet comments from disgruntled customers now trapped in the pool suggest many of them misunderstand the basic difference between savings and investments. The former is cash set aside that is still freely available for day-to-day expenses, while the latter should be viewed as locked away for retirement.

But the ability to withdraw money on a daily basis gave the impression of complete liquidity. In normal times, the mismatch between the speed at which assets can be offloaded and the pace at which investors can demand repayment can be ignored. When things go awry – as has happened time and again in recent years – the illusion is shattered.

The global financial crisis arguably started on Aug. 9, 2007, the day that France’s BNP Paribas SA froze redemptions from three of its funds after concluding that it couldn’t determine the value of their underlying assets because there was no market for them. Since then, liquidity has become a key focus for responsible money managers.

Four years ago, worries about a lack of turnover in the bond market were making some nervous. So Martin Gilbert, who then oversaw $112 billion at Aberdeen Asset Management Plc, set aside $1 billion of cash and set up a $500 million overdraft. It was a safeguard “in case you have to meet a redemption and there is no market,” he told Bloomberg Television at the time.

But even a renewed awareness of how quickly liquidity can evaporate hasn’t prevented stumbles. In Dec. 2015, U.S. firm Third Avenue Management halted redemptions from a $788 million credit vehicle after suffering outflows of almost $1 billion. Customers got back less than half of their money in the following year as it struggled to offload assets at acceptable prices. And two years ago, Blackstone Group LP closed a $3 billion distressed-debt pool after concluding that the periodic withdrawals clients were allowed to make were hurting returns, especially compared to rivals with longer lock-ups.

“More than $30 trillion of global assets are held in investment funds that promise daily liquidity to investors despite investing in potentially illiquid underlying assets,” Bank of England Governor Mark Carney said in a speech in Tokyo last week. He was talking about emerging markets; but he also referred to the U.K.’s experience after the 2016 Brexit referendum, when a wave of redemption demands forced seven domestic property funds with about 18 billion pounds ($23 billion) of assets to halt trading.

So the potential for a dangerous disconnect between the ability to buy and sell assets swiftly and the rights of clients to retrieve their cash on a daily basis isn’t a new development. But the wrong response would be to ban such funds, even those targeted at individual investors, from buying unlisted and closely held securities. Backing fledgling businesses is a key way of growing the economy. And retail investors shouldn’t be denied the opportunity of making outsized returns from betting on fledgling companies that could develop into world-beaters.

Woodford’s 10 percent limit seems reasonable. The problem, as I wrote last week, was the way he rejigged some of those holdings – including listing some holdings on the Guernsey International Stock Exchange and transferring others to a separate entity which was owned, in part, by the firm’s flagship vehicle. As he tried to turn around his performance – which he himself called “painful” back in September 2017 – Woodford ended up playing fast and loose with the definition of a liquid investment.

In his defense, he has been a paragon of transparency about what he was doing with his customers’ money, at least until recently. But there is a bigger question about whether the Financial Conduct Authority, which must have been aware of his shuffling of the pack of holdings in recent months, should have intervened earlier.  

Looking ahead, tighter regulation about just what counts as a liquid security is clearly needed. That may capture the asset mixture of other funds that are currently flying under the radar because their performance hasn’t prompted clients to flee. Less frequent access for investors – after all, daily redemption rights are more appropriate for an ATM than a nest egg – should also be considered.

And if the authorities stick with the current system of allowing money mangers who get into difficulties to drop the gate on redemptions, it will be essential to remind consumers about the risk that their cash may be locked in. If that deters some potential customers, they probably shouldn’t be buying in the first place.

To contact the editor responsible for this story: Edward Evans at eevans3@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Mark Gilbert is a Bloomberg Opinion columnist covering asset management. He previously was the London bureau chief for Bloomberg News. He is also the author of "Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable."

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