Following the high-profile collapse of star manager Neil Woodford’s empire, Dewi John offers some key questions advisers should ask fund managers
Unless you have a particular taste for the macabre, autopsies are never fun. That does not mean they are not necessary – and with the collapse of Neil Woodford’s fund empire, autopsy is certainly needed when it comes to the cult of the star manager.
Many former stars have imploded dramatically in the past 20 years: Rory Powe, who managed the Invesco Perpetual European, stuffed the portfolio with tech and lost more than half its value in a year up to 2001; Anthony Bolton, whose Fidelity China trust lost more than a third of its value in 2011; not to mention the collapse of an entire star manager house – New Star – during the financial crisis. And the list goes on.
When Mr Woodford set up his own firm in 2014, he raised £1.7bn in a fortnight. Assets rose to £16bn but the whole thing was brought to a sorry end last year following cataclysmic underperformance, mainly through holding illiquid and unquoted stocks.
What, then, are the lessons advisers can salvage from this wreckage? What questions should you ask fund managers to help avoid this happening again?
1. What is in the portfolio?
Gone are the days when you can look at the top 10 holdings on the monthly factsheet, nod happily at the solid blue-chip names and carry on. These will most likely not be the greatest contributions to risk or return. For that, you need insight into what’s in the portfolio. Transparency is key.
2. Which stocks are the greatest contribution to risk?
Any portfolio manager will know this. Indeed, it probably keeps them up at night. Ask which stocks are their greatest contribution to risk, how they are defining that risk (it is generally volatility), and what their investment thesis is for holding it?
3. What is your sell discipline?
Understand what a manager’s sell discipline is – and do they stick to it? While many portfolio managers can be good at buying securities, they are often not so good at selling them. Managers become attached to a stock: if it’s performed well, they hope that it will continue to perform; if it’s dropping like a stone, they pray that it will rebound if they just hold their nerve.
A manager will have a standard example of their sell discipline, which they wheel out for presentations. Great. But are there examples that you can determine from the portfolio where they have not done this? And, if so, why have they not – and why have their own risk controls let them get away with it? There may be very good reasons for an exception to the rule, but you need to understand what they are. And if there are too many, you do not have an investment process – the portfolio manager is freestyling.
4. How long does it take to liquidate your portfolio?
This may well be part of a portfolio manager’s internal risk reporting – how long do they calculate that it would take to sell out of the entire portfolio? While there is no standard second-order metric, typically it is for 80% or 90% liquidation. For a large-cap developed-market equity portfolio, both metrics should not be longer than two to three days, since large caps are very liquid. However, for funds with many billions in assets under management, the liquidation period could be longer, as they would otherwise move the market if they sell everything at once. There is no guarantee that target liquidation times are actually what happens, particularly in a falling market when everyone is running for the exits, but you will get some idea of how liquid the portfolio is.
5. What is the highest percentage of a stock’s free float you can (and do) hold?
If a manager holds a significant percentage of a company’s shares, the very act of putting money into the company will increase its share price. But the same is true in reverse: once you try selling those shares, the price will likely go into reverse. ‘Pump and dump’ is ethically questionable as an investment approach, but for it even to work, you have to be able to dump.
Getting out of a position is no easy task, as Mr Woodford discovered. He held almost a third of estate agent Purple Brick’s shares. That bumped their price up, but then they dropped from nearly £5 in 2017 to just above the initial public offering price of £1. He also held about a quarter of the doorstep lender Provident Financial, which had an even more precipitous fall, from £26 in 2015 to £5.80 two years later.
This liquidity issue is not necessarily the same as greatest contribution to risk. Indeed, if a manager is steadily buying a stock, it may consequently be rising smoothly and not seem that volatile.
None of the above will copper-bottom your fund selection – as we have discovered, there are any number of ways a portfolio can go south. But liquidity is a key issue.
Dewi John is a freelance journalist