While we sleep an important lesson is unfolding in the UK. One that I hope our own financial markets regulator is watching closely and learning from.
For Kiwi investors’ the lessons will have an element of déjà vu. A giant frozen fund. Investors not knowing when they’ll get their money back. Politicians clambering for explanations.
But this time it’s happened in a highly regulated market, where the Financial Conduct Authority has teeth like a crocodile. It involves fund manager Neil Woodford, with 30 years unblemished experience and a CBE for services to the British economy. And it centres on an Equity Income Fund. A sector that prides itself on being as dull as dishwater.
Woodford was a safe pair of hands for decades. The ‘Oracle of Oxford’ they called him. A great stock-picker and never flashy. He’d calmly avoided the dot.com bubble of the late 1990’s and navigated the 2008 Global Financial Crisis by avoiding banking stocks before others clocked the problem. He flourished because his defensive game was spot on.
After a long career at Invesco Perpetual, Woodford Funds was born and investors followed. At its height he attracted $20 billion of savers money. Two years ago, performance began to suffer and larger investors lost patience. Outflows have been chunky and steady, with market losses adding to the contraction. There’s still $7.5 billion invested, but frozen.
What went wrong? Liquidity.
It’s a lesson in star funds trying to get an edge. Buying companies, that are not listed (unquoted) or whose shares trade irregularly might be clever and full of potential, but it’s also a minefield.
In the UK, a fund can hold up to 10 percent in unquoted stocks.
Woodford’s investors started withdrawing due to bad performance. Holdings that were quoted, but traded irregularly, became more illiquid in the difficult market conditions of 2018. The percentages on the illiquid-list shot up and advisers, investors and the regulator noticed. Some cut and ran. Now 40 percent of the fund isn’t easily traded.
Woodford is also a lesson in the sly but legal ways of making shares ‘appear’ more saleable. He listed some on an exchange in Guernsey. He tipped others into a listed company he owned. Voila. The unquoted are now quoted and liquidity ratios improved.
That helped with window dressing, but didn’t solve the problem when investor withdrawals chugged on. It was still lipstick on a pig and the fund had to be frozen to protect those remaining.
Liquidity in New Zealand funds
It’s hard to explain the lack of depth in New Zealand regulation, but it’s significant and exposes investors.
Even the International Monetary Fund is overly polite, when it says our liquidity rules are “lightly prescribed”. The truth is our legislation prescribes absolutely nothing in terms of liquidity, diversification or concentration limits.
Fund managers self-prescribe in a Statement of Investment Policy and Objectives. Some of these make squeamish reading and involve only a few simple lines like “The funds should have sufficient liquidity to meet ongoing short term operational requirements”. We’ll have to trust them on that one. Or, “We stress test our funds every three years”. I’ll grab a coffee while I wait then. They set themselves limits like the 10 percent rule, but illiquidity takes many forms.
In some ways we have little to worry about. KiwiSaver investors are well and truly stuck. Once you’re in, you can’t get out. So withdrawals are limited to those buying homes and retiring. If the manager’s liquidity ratio falls, they’ve time to manage their way out of it, unless investors master the art of switching. That reality is a risk.
As can be seen on the table, many fund managers run at 100 percent liquidity with no illiquid holdings. Yet others like Milford Asset Management’s Growth Fund have over 20 percent in holdings that take longer than five days to sell. Westpac have 13 percent. Without any ‘bucket’ information showing time estimates, we have no idea if it’s a concern or innocuous.
Outside of KiwiSaver the Milford Diversified Income Fund carries 30% of investments that can’t be sold within 5 days. The Trans-Tasman Bond Fund has 25 percent and their Balanced Fund 19 percent. Again, without fuller information, nothing can be read into it.
Investors have no-show of finding a liquidity ratio. Navigation of the Disclose Register on the companies office website is not something your mum does on a Sunday afternoon.
As for Woodford, the vultures are circling. Newspapers are demanding he stops charging fees. Others have predicted the fund will be wound up with illiquid shares sold over time and partial payouts.
How can our own regulator prevent déjà vu? Start taking a very big interest in fund managers’ holdings of unquoted shares, shares with limited market trading and the fund-of-funds scenario where illiquidity exists within the layers.
KiwiSaver: Percentage of illiquid shares*
Janine Starks is a financial commentator with expertise in banking, personal finance and funds management. Opinions in this column represent her personal views. They are general in nature and are not a recommendation, opinion or guidance to any individuals in relation to acquiring or disposing of a financial product. Readers should not rely on these opinions and should always seek specific independent financial advice appropriate to their own individual circumstances.