Panorama on Woodford – Expletives Deleted?

Panorama covered the Woodford debacle last night and the issue of conflicts of interest in fund managers. They tried door-stepping Neil Woodford to ask him some questions, but he just walked past them. I think the questions would have been rhetorical anyway, such as “why did he make so many duff bets on companies” and “why should he have made millions while investors in his funds lost money”?

The Financial Conduct Authority (FCA) came in for a lot of criticism for not intervening sooner and allegedly not enforcing the rules concerning the liquidity of holdings in open-ended funds.

My old sparring partner T** W** was interviewed in his new home in Wales – looks like he has a renovation project on his hands. I don’t like to mention his name in case it attracts readers to follow him when they might find his use of language somewhat offensive. But in this interview there were no expletives which is unusual for him – perhaps the BBC deleted them.  They also interviewed some investors in the Woodford funds and one of them definitely had her expletives deleted.

The programme also covered the issue of the conflicts of interest in fund managers such as the fact that as their fees are based on the value of funds under management, there are strong incentives to grow the assets and also an incentive to manipulate the share prices. For example, without suggesting that Woodford specifically did these things, if a fund manager buys more of a listed stock in the market then that can raise the price, particularly when the stock is a small cap one and relatively illiquid. In the case of unlisted stocks, investing at a higher price than any previous trades causes the whole company to be revalued upwards (see BVCA valuation rules). There is clearly the possibility of perverse incentives here.

The programme also mentioned the case of Mark Denning an investment manager for Capital Group who allegedly had been trading in stocks on his personal account that were also held by the fund he managed. He denies it, but clearly such activity could enable “front-running” of trades and other abuses. The Panorama programme argued that there was in essence very little oversight of fund managers.

In summary the BBC programme was a good overview of the issues and T** W** made a useful contribution. The FCA should certainly be tightening up on the oversight of open-ended funds and their managers, and should be reviewing the liquidity rules even if they are bound by the EU Directives in that regard at present.

As the FCA never acts quickly, which is of course part of the problem, in the meantime investors might like to consider what I said in my recent book in the chapter on Trusts and Funds. I repeat some excerpts here:

“A key measure of the merit of a fund is its long-term performance against similar funds or its benchmark”. [Woodford’s funds, after he set up his new management company. never demonstrated that].

“One issue to examine is whether a fund manager has a consistent and effective process for selecting investments if they are an active manager. It is important that they are not simply making ad-hoc decisions about investments however experienced they are”. [See my comments on City of London Investment Group in a previous blog post for an example].

“To judge whether a fund manager is competent it helps to look at the underlying companies in which they invest. Are they investing in companies that show a high return on capital while being on relatively low P/Es and with significant growth in earnings or are they investing in shares that appear to be simply cheap? Are they picking companies that are of high quality – in other words displaying the characteristics covered in the first few chapters of this book?” [Anyone looking at the holdings of the Woodford Equity Income Fund or Patient Capital Trust would have realised that many of the holdings were speculative].

One issue not raised in the BBC programme was that of the naming of the Woodford Equity Income Fund. Such funds typically focus on paying high dividends to investors and to do so they invest in high dividend paying companies. They therefore tend to hold boring large cap companies. But the Woodford fund was very different. It did have some high dividend paying holdings in the fund but not necessarily large cap ones and it also had a number of early stage companies that were unlisted. This was not a typical “Equity Income” fund. Investors might feel they were misled in that regard by the name.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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