The fallout from the suspension of redemptions by Neil Woodford’s Equity Income Fund has led to closely linked Hargreaves Lansdown PLC (LON:HL.) losing 10% of its market value and analysts expecting repercussions to spread much wider in the wealth management industry.
Regulator Financial Conduct Authority confirmed on Wednesday that it was taking a closer look at the issues around illiquid investments and wealth manager St. James's Place PLC (LON:STJ) terminated its £3.5bn mandate with Woodford Investment Management to manage funds for its clients.
After the Woodford fund was frozen to investor withdrawals on Monday, the star fund manager himself issued a video on YouTube on Tuesday night to tell investors he was “extremely sorry” and while “clearly frustrating for you as investors, we felt was necessary to protect your interests”.
Late on Wednesday, a potentially crushing late blow came from St James Place to remove its mandate from Woodford in favour of Columbia Threadneedle Asset Management, while Hargreaves Lansdown announced that it was now waiving the platform fee while the fund is suspended and has "put pressure" on Woodford to do the same.
Woodford's decision to put investment in the fund on pause was taken after investors withdrew around £560mln from the fund over the past four weeks, bringing redemptions over the past year to April up to around £1.8bn from the star manager’s flagship fund.
Outside of the growing crisis at Woodford IM, investors and sector watchers were quick to look at how reverberations would spread to other linked companies.
Even greater than the links to St James’s Place, Hargreaves Lansdown is seen as having a particularly close relationship with Woodford.
Part of fund shop Hargreaves’ business model is agreeing deals with some fund managers to provide discounted annual management charges for its 1.1mln customers, with the Woodford Equity Income Fund (WEIF) one of the funds also recommended to its legion of investors as part of what was the Wealth 150 list of preferred funds.
Woodford’s shining reputation after his highly successful years at Invesco Perpetual and HL’s recommendations led to the company’s customers holding a massive 30.5% of all the money in the WEIF at the end of last year and around £2bn of Woodford’s £10.1bn total assets at the end of March.
Hargreaves kept the fund and Woodford’s Income Focus Fund in a shrunken Wealth 50 earlier this year, despite worse-than-benchmark performances, and only removed list of funds on Monday.
"For the likes of Hargreaves there is a trust issue as they were pumping this fund to clients and clearly it was underperforming,” said Neil Wilson, chief market analyst at Markets.com. “It should also make people in the industry reflect on top funds lists."
Media attention on the link between the companies has been intense, with leader writers in The Times newspaper thundering that recent inclusion on the Wealth 50 buy-list was “a failure of due diligence”, while the Financial Times quoted a rival broker who said it was “a conflict” as Hargreaves “had access to a cheap share class which they promoted to their benefit”.
Hargreaves Lansdown director of research Mark Dampier indicated to clients on Monday that: "We have made the decision to remove the Income Focus Fund from the Wealth 50 as we would prefer to see a resolution to the dealing suspension of the Equity Income fund before making a decision on whether the Income Focus fund should continue to be on the buylist."
Open-ended fund structure
Other questions being asked were about the structure of Woodford’s Equity Income Fund, whether it had contributed to the problems and whether regulators would need to tighten up the rules.
The WEIF is an open-ended fund, or unit trust, which means they are always open to new investment and as investors invest it provides the money straight to the manager but when money is pulled out in volume they are at a disadvantage.
If redemptions rise, open-ended fund managers need to create the cash to give departing investors and, if there isn’t any, they need sell some investments to generate the money.
So as investors pulled out more than £0.5bn in the past few weeks, the WEIF fund faced extra problems as some of its investments were in unlisted securities, with the consequent lack of liquidity. Some investee companies were listed on the Guernsey stock exchange to skirt regulatory restrictions.
FCA fund scrutiny
After calls for regulators to examine how a fund marketed to small retail investors and pension savers could invest in such specialised securities, the Financial Conduct Authority on Wednesday confirmed it is in discussions" with Woodford’s authorised director Link Fund Solutions and the Guernsey stock exchange over the listing of illiquid holdings on the Channel Islands-based International Stock Exchange.
As part of the fund manager’s efforts to provide extra liquidity to his fund, Woodford had pushed some of the unquoted investments into listing on the Guernsey Stock Exchange, which allowed him to comply with the rules forbidding an open-ended fund from having more than 10% cent of its assets in unquoted companies.
Link had previously said Woodfords’ move was "eligible" in compliance with the European Union’s UCITS directive.
The FCA said it was not informed “and would not have expected notice” of any decision to list the fund's assets prior to their listing, but said it expects any such decision "to be in compliance with the relevant rules…to ensure the fund's assets remain sufficiently liquid and diversified".
The City regulator added: "The FCA has been in discussions with Link Funds and TISE regarding the circumstances around the listing of certain of the fund's assets on that exchange.
"Where the FCA believes there are circumstances suggesting serious misconduct or non-compliance with the rules it may open an investigation."
Short-term sentiment and long-term lesson
As ever, there were positive voices from the industry.
Deutsche Bank noted that the Wealth 50 recommendations “have generally outperformed benchmarks over time, and this should not necessarily cause any long-term damage to the group”.
But the Deutsche analysts did acknowledge that in the short-term newsflow around HL would be “overshadowed” by Woodford news, said “it does serve to caution wealth management companies not to become too close to individual fund manager” and reiterated a ‘sell’ recommendation on the shares due to their full valuation.
Charlie Musson, spokesman at HL’s rival AJ Bell, said that “events such as this are extremely rare" but for the wider wealth management sector he admitted it was a reminder of the risks that come with investing in illiquid assets while offering daily liquidity to investors.
“This doesn’t seem like a problem when money is coming in to a fund but if sentiment turns it can become a problem as we have seen here and with property funds that were suspended following the Brexit vote and the subsequent hit on commercial property values.”
HL shares were down 6% on Wednesday to 2,000p, while the Woodford Patient Capital Trust PLC (LON:WPCT) were more than 7% lower at 65.7p.