There’s no such thing as a fund manager with the Midas touch

Editorial Comment: there are valuable takeaways for private investors following the Woodford saga, says Faith Glasgow

We have charted the sorry progress of Neil Woodford and his stable of funds since the suspension of the flagship Woodford Equity Income fund back in June; it’s a train of events with far-reaching implications for the fund industry.

The whole episode raises big questions about fund ‘policing’ and structure – not least whether retail-focused funds should hold the money of large institutional investors that could seriously rock the boat with a single substantial withdrawal, as Kent County Council’s withdrawal did for Woodford Equity Income.

But it is not just the industry that needs to learn from this debacle. There are several valuable takeaways for individual private investors. The hundreds of thousand of investors in Woodford Equity Income could face a ‘haircut’ of between 30% and 70% of their money when the fund is wound up, according to Martin Bamford of adviser Informed Choice.

Learn portfolio lessons

So what are the lessons for self-directed investors?

• Beware the cult of the star fund manager – particularly when their focus of attention departs from the area in which they established their reputation in the first place. Woodford made his name 20 years ago as an investor in unfashionable blue-chips paying generous dividends at a time when technology stocks were all the rage – a far cry from the unlisted start-ups that finally proved his undoing. (Andrew Pitts looks in more detail at the potential dangers attached to high-profile launches in the December issue of the magazine.)

One consideration to bear in mind is that star managers who leave a well-resourced, team-based management group to set up on their own tend to be less successful. A recent study by AJ Bell found that six of the seven big names to go it alone in the last few years have suffered a fall in performance.

• Remember eggs and baskets. You might well fancy a piece of a favourite fund manager’s new venture, whether it’s a fund or a whole new business; but treat any such investment as high-risk and limit exposure to a small part of a diversified portfolio, rather than piling in on the assumption the manager will work the same old magic as last time.

• Be wary of buying illiquid, hard-to-sell assets – unquoted stocks being one prime example and direct property another – in an open-ended fund. If there is a run on it, the manager will have to sell assets in order to meet redemption demand, which may be very difficult or involve accepting a heavily discounted price. The alternative for the manager is to keep a hefty proportion in cash, which tends to detract from performance as it’s not generating investment returns.

This is where investment trusts come into their own. Because investors own shares traded on the stock market, a run on the trust may decimate the share price and widen its discount to net asset value – but it doesn’t impact the management of the underlying assets. Managers can invest for the long term and don’t have to worry about liquidity issues.

• Don’t treat a fund’s appearance in a broker’s best buy table as a substitute for doing your own research. Woodford Equity Income appeared on the Hargreaves Lansdown Wealth 150 buy list and remained there when the list was reduced to 50-60 funds. It was not taken off the list until the day trading was suspended. Hargreaves’ clients held about £1.4 billion of the fund at the end of 2018, though other brokers also helped fuel the fire through their recommendations of the fund.

The Woodford saga highlights the influence of buy lists in helping private investors make choices between the 3,000 plus funds on the market – but it also underscores the fact that if something goes wrong, they have no recourse. The bottom line is that buy lists should be treated as a jumping-off point for further research, rather than as ready-made recommendations.

None of these points are revelationary for Money Observer readers, of course; but they do remind us that there’s no such thing as a fund manager with the Midas touch: continuing outperformance is never guaranteed.

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