Stock markets may fall and rise on trade war talk and possible rate cut hopes.
Fading economic growth may be tempting you to sell at least some of your shares.
But what if you can’t get out?
This week’s news that asset manager Neil Woodford has suspended trading in his flagship Woodford Equity Income Fund is a shattering blow for his investors.
Perhaps you’re one of them. And even if you’re not, you may be asking what it means for equity markets in general and your own portfolio in particular.
Let’s have a look…
The fund suspension was caused by one simple reason. Increasing numbers of investors asked for their money back. For example, Kent County Council’s pension fund had wanted to withdraw its £263m investment, but was unable to do so before trading in the fund was suspended, reports the BBC.
“I’m extremely sorry”, says Mr Woodford. The move was “necessary to protect investors’ interests. We will use this time to reposition the fund”.
That’s another way of saying that he’s being forced to sell holdings to raise cash for funding withdrawals from the portfolio. The asset manager has also confirmed that he needs to cut its exposure to illiquid and unquoted shares – which may be tough to sell – “to zero”.
Sadly, this isn’t a huge surprise.
Woodford has a great long-term track record. But his star has fallen in recent years as his portfolio performance has declined. While every fund manager makes mistakes, he’s picked too many stocks that have gone wrong. That applies to the Woodford Equity Income Fund.
Of course, it’s very tempting to crow about the discomfort that Mr Woodford will be feeling right now. Indeed, there’s been the inevitable journalistic analysis of what’s gone wrong (largely from people who’ve never ‘run’ money in their lives).
But if you’ve ever been there, you’ll probably feel some sympathy from Mr Woodford’s current plight.
I certainly do.
In a City career spanning nearly 25 years, much of it managing other peoples’ money, I enjoyed some great successes when everything seemed to turn to gold.
But I also endured other torrid times when my portfolios underperformed and my ideas simply didn’t want to work – or indeed, just plain went wrong.
Why was this? Sometimes markets work in your favour, and sometimes they don’t.
Until a month ago, for example, tech stock fund managers were having a great run because the underlying sector was soaring. As it did in the years before the Millennium when ‘dotcom’ was the only game in town.
Meanwhile, value managers seriously suffered pre-2000 (and yes, I was running a value fund in those days!)
Lucky or good?
Or maybe it’s just a matter of luck.
Many financial market professionals love to convince themselves that they’re uber-smart and that good fortune – or the lack of it – doesn’t influence their performance.
Don’t believe it
When Napoleon Bonaparte was criticised for winning battles simply because he was fortunate, he replied “I’d rather have lucky generals than good ones”.
More than 100 years later, Eisenhower expressed similar sentiments when he said “I’d rather have a lucky general than a smart general. They win battles”.
I believe the same maxim applies to fund management. When it’s going well, you get lucky. When it’s not, your stocks seem to attract misfortune.
Or maybe it’s a simple as this. Perhaps it’s impossible to beat the market over time. So if asset managers stay in the business for too long, they’re bound to underperform at some stage.
And here’s where we reach the root cause of Neil Woodford going awry.
The clue is in the name of his portfolio.
“While the flagship fund was called ‘Woodford Equity Income’, it derived most of the dividends from a small number of holdings, while also owning lots of small stakes in early-stage biotech stocks and the like”, notes John Stepek, my former colleague at MoneyWeek magazine. “In March, The Times noted that fewer than a third of the stocks in the fund actually paid a dividend.”
In other words, Woodford has been ‘playing away’ from his core income share base. Despite that earlier strong run in tech stocks, this approach hasn’t worked out.
Why has he done this?
Again, I feel some sympathy here.
For all asset managers and for stellar stock pickers in particular, the ongoing pressure to beat the benchmarks is immense. Indeed, it’s increasing all the time.
Classic income shares have been broadly out of favour. So Neil Woodford has tried – unsuccessfully – to spice up the fund’s performance with smaller stocks.
It’s a problem about which I’ve written several times in recent years.
The higher that equity markets rise on swollen stock valuations, the more difficult it is to find good value investments that will beat the index.
Even the great value protagonist Seth Klarman has found performance very hard to achieve in recent years.
This suspension is clearly a huge blow to Neil Woodford personally, as well as to his backers Hargreaves Lansdown. “While Hargreaves Lansdown’s reputation for service is undimmed”, says Gavin Lumsden on Citywire, “the credibility of its investment guidance and stewardship of customers is damaged”.
So if you’re a Woodford investor, what now?
With the fund currently suspended, there’s no immediate decision to be made. You couldn’t extract your cash now even if you needed to.
Investors will hope that when the suspension is lifted, they’ll be able to withdraw their money at a similar level to before. But don’t bet on it. The market will have marked down the prices of some of those smaller stocks, making them even harder to sell than previously.
That’s worrying enough. But the bigger picture is yet more concerning.
It illustrates the dangers of counterparty risk and how the ripples of one mishap can spread very widely and hurt many people who thought they weren’t affected. How might it damage Kent County Council’s pensioners, for example?
And remember, this has emerged at a time when equity markets have been strong. What if a bear market hits and other fund suspensions happen elsewhere?
The fallout could get very messy indeed.