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Earlier this month, Woodford Investment Management suspended redemptions from the Woodford Equity Income Fund, in a move which surprised many of its investors. Although much of the subsequent press coverage has focused on the impact on individual investors, the events do provide a number of lessons for pension schemes.
Understand what you’re holding and how liquid the underlying assets really are
There has been an increased appetite for illiquid assets in recent years, as investors search for higher yields. Some fund managers have increasingly looked to market vehicles which allow access to less liquid assets. However, wrapping an illiquid asset in a daily-dealt pooled fund doesn’t suddenly make it a liquid asset. For example, some funds might advertise that they might hold up to 10% in less liquid assets, but if disinvestment levels are high then that leaves a simple choice to either sell liquid assets, (which increases the proportion of illiquid assets left in the fund), or suspend redemptions – which leads neatly to the second lesson.
Understanding the managers’ terms or rights if things go wrong
If a manager is holding less liquid assets, then they will normally have the right to suspend redemptions. This is a decision that they may well take to protect their remaining investors who, could otherwise become caught up in the losses caused by a fire sale of assets. Despite the recent press comment, it may actually be in the best interests of many investors, as there could be an orderly sale of the less liquid assets rather than letting people disinvest as quickly as possible. The key point here, is that investors in funds that hold illiquid assets, shouldn’t be surprised that they can become difficult to exit.
Know who else you are invested alongside
It’s clear that a high volume of redemptions can cause problems for a fund, but understanding the make-up of your co-investors can help to manage this risk. Key questions might be understanding to what extent you are investing alongside other institutional investors with similar time horizons or whether the fund is largely comprised of ‘retail’ investors who may be more influenced by recent sentiment/performance. Likewise, you should also understand if significant proportions of the assets come from a few key sources, since this will increase the risk of a sudden rush of disinvestments. Key risks might be from one or two large investors, holding most of a fund or a few large intermediaries having provided the majority of the funds via their recommendations.
Understand the fee relationships between investment managers and intermediaries
Another question being asked about the Woodford saga is around the income received by intermediaries and whether their interests were correctly aligned with clients. The Competitions and Markets Authority (CMA) have been pouring over the details of blurred lines between managers and advisers other the last few years, but this again highlights the power of getting genuinely independent advice.
However good you think a particular star manager might be, the old adage about eggs and baskets still holds true – a well-diversified portfolio can cope with small elements becoming less liquid, but a poorly diversified portfolio becomes more susceptible to adverse events.