The gating of Neil Woodford’s flagship LF Woodford Equity Income fund has sparked a new debate over unlisted holdings and liquidity, according to Psigma Investment Management’s Thomas Becket. 
With concerns over fund liquidity resurfacing for the first time in several years, Becket said there are several “red flags” that investors should look out for and avoid.
The LF Woodford Equity Income fund was gated – suspended to new subscriptions and redemptions – at the start of the month as investors started to withdraw money following concerns over performance and exposure to illiquid holdings.
The Psigma chief investment officer said: “The issues that are arising at Woodford Investment Management are coming from the problematic mix of heavy investor redemptions and a sizeable weighting within the fund to illiquid unlisted company shares.
“As a guide to how we view such investments, we would consider them to be a ‘red flag’ within our fund selection and due diligence processes and certainly could not contemplate recommending a fund that had quite such a high allocation in such investments in a daily dealing unit trust that Woodford’s daily dealing Income fund held.”
Becket (pictured) said managing liquidity appropriately within portfolios is an important consideration in its process and will only invest in daily dealing, Ucits-recognised funds.
“The first point to make is that we take liquidity incredibly seriously,” Becket said. “And questions over liquidity are as vital to our assessment of the suitability of a specific fund as the potential for returns and risks are.”
As such, Becket – who oversees the MI Psigma Multi-Asset Balanced Fund of Funds – said the firm will not bend on this rule within its investment process, making only isolated exceptions in specialised situations where less frequent dealing is beneficial to its clients.
The Psigma investment chief said it carries a “great deal of due diligence on the underlying investments held within each and every fund” that it recommends to clients.
This, he said, allows the firm to spot illiquid, unlisted company shares within the fund, one of the firm’s major “red flags” surrounding fund liquidity.
But, even with the best intelligence and due diligence, the chief investment officer acknowledged that they could not fully protect themselves from wider market circumstances negatively impacting the fund.
“As the situation with the Woodford Income fund is currently showing, our blunt rule is insufficient in trying to ensure that our clients’ assets do not become gated in external funds in extreme market scenarios,” he added.
The Psigma investment chief also noted that their focus on liquidity and protecting investors can even force them to miss out on good investment opportunities.
Close and regular monitoring of changes to a fund’s portfolio can also flag up any potential threat to liquidity, said Becket.
“We regularly ask external fund managers to detail to us how long it would take them to liquidate their whole portfolio,” he said, “providing us with extra insight into how we can manage liquidity risk in stressed market conditions.”
Fund size is another important consideration for investors, the MI Psigma Multi-Asset Balanced Fund of Funds manager said.
“Our bias is to avoid very large funds when investing in fixed interest markets, which can be less liquid than investing in equity markets, particularly when investing in corporate credit or asset-backed securities markets,” the Psigma investment chief explained.
As such, Psigma places its clients in custom-made vehicles for fixed income exposure, which Becket said gives it greater control over liquidity and means it is not at the mercy of other investors.
“We specifically review a fund where they are enjoying a great deal of success in growing assets and when a fund starts to lose assets, outside of ongoing market movements,” he added.
“Fund flows undoubtedly can help or hinder a manager’s ability to generate performance and are underestimated as risk factors in our view.”
Performance of fund vs sector & benchmark in six months to 31 May 2019
Source: FE Analytics
According to data from FE Analytics, the LF Woodford Equity Income fund has suffered outflows of £742.3m in the six months to 31 May 2019. During this time the LF Woodford Equity Income fund has lost 11.18 per cent compared with a 5.18 per cent rise in the FTSE All Share benchmark and a gain of 4.99 per cent for the average IA UK All Companies peer.
Yet, with renewed concerns over liquidity, it seems that investors have failed to learn the lessons of the past.
The Psigma chief investment officer said: “We are amazed by how quickly our industry has forgotten the problems that arose in the financial crisis of 2007-2009, where many funds became gated and suspended redemptions.
“Indeed, perhaps the biggest culprits that prevented investors withdrawing their money a decade ago were the ‘bricks & mortar’ UK commercial property funds, where such property funds’ mix short term investor cash flows with long term illiquid assets.
“But it took less than a decade for them to repeat the trick as news over the UK’s decision to leave the EU impacted prices and worried investors tried to pull their assets.”
The MI Psigma Multi-Asset Balanced Fund of Funds was launched in December 2018 and invests globally across asset classes aiming to deliver a return in line with the UK consumer price index (CPI) plus 3 per cent (after fees) over a seven-year period. It has a maximum equity weighting of 60 per cent and a maximum higher risk fixed interest weighting of 15 per cent. The fund will also hold up to 15 per cent in alternative strategies to reduce volatility historically associated with a purely equity-based portfolio.
Performance of fund vs benchmark since launch
Source: FE Analytics
Since launch, the MI Psigma Multi-Asset Balanced Fund of Funds has made a total return of 5.98 per cent. It has an OCF of 1.13 per cent.