Woodford fund frozen

The rise of alternative finance since the credit crunch has opened the eyes of many retail investors and advisers to potential alternatives to traditional cash savings and stocks and shares trading.

P2P, EIS (enterprise investment schemes) and DBS (debt-based securities) – these are just some of the acronyms an average person may encounter when deciding what to do with their money. While none of them are appropriate to every scenario, all of them are appropriate to some (for when, see our industry guides and reports).

In contrast to the rock bottom interest rates offered by banks, these products have offered much better returns over the past decade– at the expense of additional risk.

One of the risks of these products is they can involve non-readily realisable securities.  Customers being sold these products need to be aware of these liquidity factors when making their investments.

The FCA recently released its updated regulations on the P2P market, and one of the concerns they are intended to address is that consumers have not always been aware of these risks, and did not appreciate the differences between the P2P product and a normal bank account.

The dramatic fall from grace of Neil Woodford’s fund empire this month, though, has raised public awareness over the term ‘liquidity’, and not in a good way. Akin to what the 2008 financial crisis did for  credit profiles, and Blue Planet 2 did for the dangers of single use plastics.

Among Woodford’s issues has been large numbers of investors attempting to withdraw funds when his Woodford Equity Income Fund began to perform poorly, while the fund had too much capital invested in assets that could not be easily accessed when needed. This caused a major liquidity bottleneck for the former stock picking favourite.

The Woodford Equity Income Fund is an open ended company (OEIC). This type of fund is subject  to  a 10% limit on illiquid assets, and The Financial Conduct Authority (FCA) had warned it about breaching this threshold twice in 2018. Since then, it had not technically broken the 10% rule, but according to the FCA, the fund’s exposure to unlisted securities actually reached 20%, a figure achieved by taking advantage of an EU directive allowing securities to be excluded from the 10% limit if the issuer plans to list the security within 12 months.

Perhaps the biggest issue here is the open ended structure of OEICs. One of their main selling points is daily pricing. The downside is that, if the manager experiences liquidity issues when withdrawal requests can’t be met, it has the power to suspend all dealing in the fund to protect the share price for those investors who remain within the OEIC. The solution is usually a high proportion of underlying liquid assets.

Woodford’s struggles may be worrying for alternative finance providers. Woodford has historically been a champion of the sector, with a particular interest in UK P2P, with significant positions in P2P-facing trusts and platforms. There is potential that investors could see this as an indication of unacceptable illiquidity in P2P, particularly with this new-found public awareness of the risks posed by an absence of liquidity. In fact, Woodford had fully divested from P2P Global Investments (P2PGI) and VPC Specialty Lending (VPC) several weeks before his Woodford Equity Income Fund was gated, with the proceeds presumably used to satisfy some of the mounting withdrawal requests, This points at a fairly speedy liquidation of the fund’s P2P assets, as well as a healthy demand for UK P2P assets.

Woodford also has a Patient Capital Fund, albeit using a trust structure and this may cause some to draw comparisons with the likes of alternative investments such as EIS and VCT. But they have very clear rules for investors looking to take advantage of potential growth, as well as the hefty tax reliefs on offer: For EIS qualification, for example, investors are required to commit their capital for a minimum of three years, and with no pre-arranged exit options allowed, the fact that capital could be tied up for a longer investment period is a known entity.

The FCA is currently looking at liquidity rules for open ended funds, and it will be interesting to see what lessons have been learned in it.

Regardless, for any would-be investor or adviser, the whole series of events ought to serve as a good reminder on the importance of checking the liquidity when considering investment options.

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