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FCA to revisit UK illiquid asset rules after high-profile fund suspension

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The UK’s financial regulator is reviewing its rules about open-ended funds holding illiquid assets after shares in a high-profile equity fund were suspended from trading last week.

UK boutique manager Woodford Investment Management was forced to halt redemptions from its flagship LF Woodford Equity Income fund on 3 June after a surge in redemption requests from investors. The portfolio – which was worth £4.3bn (€4.8bn) at the end of April – had a significant allocation to small cap, unlisted or illiquid companies, which hampered efforts to meet redemption requests.

Among the investors locked in was Kent County Council’s £6.4bn pension fund, which had a £263m investment in the Woodford fund as of 30 April 2019, according to the council – equal to roughly 4% of the pension scheme’s portfolio.

Writing in the Financial Times today, Andrew Bailey, chief executive of the Financial Conduct Authority (FCA), said the suspension “raises a challenge as to whether the rules requiring assets to be liquid are working as they should”.

“The FCA has consulted on new rules for funds that invest in property and other illiquid assets to strengthen liquidity management,” Bailey said. “We will take into account the lessons of the Woodford fund when finalising these new rules.”

In an effort to improve liquidity in the LF Woodford Equity Income fund, the asset manager has taken a number of measures in recent weeks. These included listing some of its unlisted holdings on the Guernsey stock exchange and swapping other holdings for a stake in the Woodford Patient Capital trust, a listed investment vehicle also management by Woodford Investment Management.

Neil Woodford

Source: Woodford Investment Management

Neil Woodford, founder and fund manager, Woodford Investment Management

Andrew Bailey, FCA

Andrew Bailey, chief executive, FCA

The block on redemptions was designed to allow fund manager Neil Woodford to complete a planned restructuring of the portfolio to remove all illiquid assets, the company said.

Bailey warned that “simply listing an unquoted company overseas does not in itself make the stock more liquid”. However, he also voiced support for “internationally open markets” and emphasised the importance of balancing liquidity and investor protection with long-term investing and fostering innovation.

He highlighted the importance of financial markets being able to support “investment in companies that will contribute to economic growth and create jobs”.

Backing start-up companies often meant investing in illiquid assets, not all of which would succeed, he continued.

“If we lose sight of this important objective, those involved in financial markets will inevitably face criticism that they are too focused on the short term and are failing to support the economy,” Bailey said.

Moody’s warns on wider impact

Credit rating agency Moody’s warned that the suspension of trading in the LF Woodford Equity Income fund could lead to stricter regulations around illiquid asset investments.

In a report published this morning, Moody’s said: “Stricter rules and requirements for open-ended funds would in our view negatively affect the business prospects of retail managers who primarily rely on active management. We believe the incident will also spur the pace of money moving into passive investments.”

It added that the FCA could require open-ended funds to hold a higher level of liquid assets, or impose “more stringent disclosure requirements”, which could in turn harm the ability of asset managers to market their funds, particularly to retail investors.

“Ultimately, the regulator could propose higher capital requirements on asset managers,” Moody’s said. “Regulatory oversight has already increased for asset managers, but the Woodford fund suspension, which directly affects retail and pension investors, will likely lead to further costly requirements for asset managers, adding to pressure on their margins.”

Nicky Morgan, chair of the UK parliament’s Treasury Select Committee, last week called for Woodford to waive the fund’s fees while trading was suspended, and said the committee would question the FCA and Bank of England about “this troubling episode”.

A nightmare week for a star fund manager

Neil Woodford set up Woodford Investment Management in 2014, attracting a huge inflow of assets – primarily from individual UK investors – on the back of a successful career at Invesco Perpetual, the UK arm of US asset manager Invesco.

At its peak, the LF Woodford Equity Income fund had in excess of £10bn of assets, but poor performance relative to its FTSE All Share index benchmark and other UK equity funds led to a wave of redemptions in recent months.

Stock price on monitor

LF Woodford Equity Income is down 10.8% in 2019

Since inception five years ago, the fund is down 3.7% compared to the FTSE All Share’s 33% gain, according to FE Analytics data. This was despite the fund gaining 40% in its first three years of operation.

In a statement published last week, Kent County Council – one of the few institutional investors in the fund – explained that the Woodford fund had been under review by its pension fund committee for several months. However, “redemptions and further weak performance” led to the pension fund submitting its own redemption request on 3 June.

On the same day, Link Asset Services – the administrator for Woodford’s funds – announced it was suspending trading in the LF Woodford Equity Income fund in order to “protect the investors in the fund by allowing Woodford… time to reposition the element of the fund’s portfolio invested in unquoted and less liquid stocks, in to more liquid investments”.

Kent County Council said it did not know whether its redemption request was the trigger for the suspension.

“The council is committed to seeking the best outcome and could still seek a managed redemption in order to maximise the benefits for the pension fund,” it stated.

Aside from the open-ended fund’s suspension, last week Woodford was sacked as manager of mandates worth £3.5bn for UK wealth manager St James’s Place, and a £330m mandate for financial advice and wealth management network Openwork.

The company’s £552.5m LF Woodford Income Focus fund and the £1bn Woodford Patient Capital investment trust both continue to trade as normal.

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