By: Tim Bennett
07.06.2019
07.06.2019
This week, investors found out that they could no longer buy and sell units in a high-profile fund run by Neil Woodford. Tim Bennett explains why.
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Why did the Woodford Equity Income Fund suspend trading?
This week, star fund manager Neil Woodford, announced that investors would no longer be able to trade units in his fund. Here I summarise why and look at the lessons for fund investors.
Background
Following a string of requests from investors to sell their units in his fund, this week Neil Woodford took the unusual decision to stop anyone from entering further trades for the time being. Investors will quite rightly be wondering what happens next.
A recap on open ended funds
Open ended investment companies (OEICs) are not actually companies at all in any conventional sense. A fund manager takes money in to invest in a range of securities – in this case the shares of some quite illiquid firms – and in return investors receive income and hopefully some appreciation in the value of their units. However, because the “shares” they hold are not tradeable on the stock market, the valuation is done by the fund with trading only allowed at specified dealing times. What’s more shares in an OEIC are bought and sold by the fund itself. The problem here arises when a fund receives many sell orders (“redemption requests”) and must find sufficient cash to meet them.
The basic mechanics
To illustrate why, let’s take a simple example. Imagine a fund has £100m of assets under management, represented by 100m shares (also known as units). If, say, £20m of the fund’s assets are in cash, then redemption of up to this amount can be easily financed. However, should the fund receive requests above this level, investments have to be sold to meet them. Where those investments are hard to trade, this can take time. In a worst-case scenario, the way a fund manager buys enough time is to suspend trading in their fund.
What happens next?
It is possible that by suspending trading and putting a stop to short-term outflows, Woodford will buy himself enough time to make the necessary sales to meet investor demand. However, there is a clear risk that the moment the fund reopens for business, the flow of sell orders will continue, and the problem will resurface.
Takeaways for investors
It is always easy to be wise after an event such as this. However, investors who follow my rules of thumb should not get caught out too badly should this happen to another fund. What this episode should remind people of is the liquidity risk that comes with “late-cycle” value investing of the sort practiced by Woodford. It is also an example of why diversification is so important. Finally, anyone looking to fulfil a particular mandate via a fund investment should always look at the closed-ended fund options alongside the OEICs on offer. Although these also carry risks, a suspension of the type we have just seen isn’t often one of them.
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