FCA launches investigation into LF Woodford Equity Income suspension

In a letter to Nicky Morgan MP, chair of the treasury committee, FCA chief executive Andrew Bailey, said: “The FCA’s Principles for Businesses require all firms, including fund managers, to exercise due skill, care and diligence and our rules require fund managers to uphold the best interests of investors at all times. Where we suspect this has not been the case in practice, we may choose to open an investigation.”

He also said that the FCA has been in contact with LF Woodford Equity Income’s authorised fund manager, Link Fund Solutions, regarding issues related to liquidity risks since February 2018. Link has regulatory responsibility in relation to operating the fund, so is accountable to the FCA. 

In February and March 2018, the FCA corresponded with Link regarding two breaches of the 10 per cent limit on the maximum proportion of unlisted securities held by LF Woodford Equity Income. Mr Bailey added: “From April to December 2018, we held monthly monitoring discussions with Link in relation to the deteriorating liquidity position within LF Woodford Equity Income. Following this engagement, Link revised its liquidity risk management measures to seek to ensure it could meet redemptions on demand. No further breaches of the 10 per cent limit were notified.”

But Link did notify the FCA on 28 February this year that the fund would be undertaking an asset swap with Woodford Patient Capital Trust (WPCT) to reduce its exposure to unquoted holdings. In March, LF Woodford Equity Income sold unquoted holdings worth £72.9m to Woodford Patient Capital Trust in exchange for shares in the trust worth 9 per cent of its market cap at the time.

The FCA then met with Link following reports that some of LF Woodford Equity Income’s unquoted holdings were listed on The International Stock Exchange (Tise), and it told the regulator that three of these had been suspended from trading. On 11 April Tise suspended dealing in Ombu, IH Holdings and Benevolent AI due to queries on whether the listings had led to a breach of FCA regulations. And from 24 April, Link began to send the FCA daily reports of all flows into and out of LF Woodford Equity Income.

Mr Bailey said: “Our preliminary supervisory inquiries suggest that the exposure to unlisted securities within the fund was around 20 per cent of the net asset value (NAV) in February 2019 prior to the Tise listing. To maintain the reposted level below 10 per cent, LF Woodford Equity Income appeared to make use of rules that derive from the European Union Undertakings for Collective Investment in Transferable Securities (Ucits) Directive, including one that allows a security to be excluded from the 10 per cent limit, ie to be deemed eligible, if its issuer plans to list that security within 12 months. There is no requirement for the fund manager to disclose this to the regulator.

“Ucits funds can invest 100 per cent of scheme property in transferable securities that are listed on an eligible market. The Ucits directive permits an authorised fund manager, after consultation with and notification to the fund’s depositary, to decide that a non-European Economic Area market is eligible on the basis of various factors such as regular operation, openness and liquidity, and having adequate arrangements for the unimpeded transmission of income and capital to investors. Link had designated Tise an eligible market.

"Nevertheless, the rules currently make it clear that the liquidity of a transferable security – listed or unlisted – should not compromise the ability of the authorised fund manager to comply with its obligation to redeem units at the request of any qualifying unit holder.”

Liquidity decline

During May 2019, net outflows averaged 1 per cent of LF Woodford Equity Income’s NAV, and redemption requests on 31 May and 3 June amounted to £296m, representing 8.2 per cent of its NAV. The fund held no cash at the time and the redemptions on 31 May and 3 June coincided with the fund repaying an overdraft facility.

Mr Bailey’s letter also notes that, even before this, there was a severe deterioration in the liquidity of the fund’s assets between 30 June 2018 and 30 April 2019, as follows, although during this period LF Woodford Equity Income was able to meet redemption requests.

Time it would have taken to liquidate LF Woodford Equity Income portfolio in normal market conditions

Source: FCA

“Having a significant amount of the fund’s assets in investments that would take 180 days or more to liquidate is highly illiquid for what is meant to be a liquid investment vehicle,” said Adrian Lowcock, head of personal investing at broker Willis Owen.

Darius McDermott, managing director of broker Chelsea Financial Services, added: “Liquidity is absolutely relevant. As part of our due diligence and research, we ask fund managers about capacity. It is of particular relevance with small-, mid- and multi-cap funds. As a very general rule, we don’t like smaller company funds that are more than £1bn in size, mid-cap funds that are above £2bn in size, and multi-cap funds with a significant weighing to small- and mid-caps above £3bn to £4bn in size. But the key lesson here is flows and pace of flows: funds with outflows are very difficult to run – especially those that invest in small- and mid-caps.”

But Rob Morgan, pensions and investments analyst at Charles Stanley, said: “People are much more focused on liquidity, which is hugely important in terms of open-ended fund flows, as with these it can [slow down] everything. But this fund’s structure and extent of the outflows were highly unusual – the liquidity issue was caused by the fund manager and the circumstances he found himself in [rather than issues with markets]. The vast majority of funds are operating with very liquid portfolios. However, don’t put any star manager on a pedestal and don’t invest a large percentage of your portfolio with any one manager.”

Information on fund flows is not easy to obtain. However, one way to keep tabs on this is to look at how a fund’s size varies from month to month, though this is also affected by market movements which may account for the majority of any changes. You can see what a fund's size is on its factsheet, which you can find on the provider’s website, or you can also find this information on data websites such as morningstar.co.uk and trustnet.com.