Years after the Woodford crash, what have fund managers learned about illiquid assets?

The ghost of Neil Woodford continues to haunt the fund management industry.

Its eponymous boutique collapsed in 2019, leaving thousands of investors suffering losses. Most of them are still awaiting repair.

At the heart of Woodford’s problem, beyond a degree of arrogance, was his open-end equity fund’s exposure to illiquid assets. These companies can offer great opportunities for growth, but they come with greater risks.

As the markets fell and a handful of his stock selections plummeted, investors withdrew their money, prompting Woodford to sell more of his publicly traded shares to meet the bailouts. This meant that its unlisted holdings, which are harder to sell, represented a larger share of the fund. It became a vicious cycle that eventually resulted in the fund being suspended, trapping investors.

What did active fund managers learn? While many companies do not have the same scale of exposure as Woodford in open-end funds, it has not been eradicated as an investment practice.

Companies such as Fidelity and Allianz are among the biggest names offering open-end funds with some holdings in unlisted companies. Others, like Schroders, will allow it if the company is to be listed soon.

Like large groups of funds, these companies have robust risk management processes and liquidity checks, with only a few of their funds owning a small amount of unlisted stocks. Some groups, however, refused to respond when asked by the FT if they held unlisted companies in open funds, suggesting a lack of transparency.

Authorized corporate directors, the fund “supervisors” tasked with overseeing a fund’s liquidity profile, are also responsible. Woodford’s ACD, Link Fund Solutions, is currently in discussions with the Financial Conduct Authority about recovering money for investors to avoid a hefty fine.

Liquidity is not the only issue. Investors can feel like they are in the dark when it comes to the value of their unlisted holdings. Unlike publicly traded stocks, the valuation metrics used for private companies are opaque. There is also a shift between public and private markets: global equities have fallen by a fifth in the past year, while private equity firms have reported modest markdowns by comparison.

Some fund houses got in on the act. Earlier this month, Jupiter’s chief executive decided that the group’s funds would no longer make new investments in unlisted stocks. The move came as its UK Mid-cap fund divested itself of a 6% stake in privately held Starling, a digital bank.

While mutual funds are much better suited to illiquid assets, analysts have warned about the amount of exposure in some cases. Private companies held by Scottish Mortgage, one of the UK’s most popular investment funds, surged above its 30% threshold at the end of last year.

Real estate funds are also problematic. Many of them failed after the 2016 Brexit vote, when nervous investors worried about valuations rushed to withdraw their investments. As a result, the funds were forced to temporarily close, trapping investors in the fund. The same blockage issue occurred again in 2020 when the pandemic set in and last year in the wake of the “mini” budget.

Some providers of open-ended real estate funds have since closed their products, citing liquidity management issues. Other countries, such as the United States and Japan, tend to opt for closed-end real estate fund structures.

The UK’s Financial Conduct Authority has proposed rules to safeguard property investors, suggesting they give a notice period to redeem so funds have time to sell property investments. It hasn’t finalized the changes yet, however.

Last week, the FCA said it was also considering rules on liquidity management across the asset management industry.

Regulators have long struggled with the problem. Even Mark Carney, former governor of the Bank of England, said in 2019 that funds investing in illiquid assets that allowed investors to withdraw money at any time were “built on a lie”.

His point was that, despite the liquidity mismatch, these funds pretend to be like ATMs. Woodford reminded us that the act can fall apart quickly.

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