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Investment lessons learned from Woodford woes

Neil Woodford has been in the news a lot this week as his flagship equity income fund has suspended trading as investors rush to the exit. Read the article below to find out who he is, what happened and what lessons to learn from this if you are an investor.

Who is Neil Woodford?

Woodford is a fund manager, managing and investing money for both individuals and big institutions, including county councils and pensions.

He made his name at Invesco Perpetual, where he ran a £30bn+ fund very well for 25 years and gained a reputation as one of the UK’s leading fund managers. He’s become a household name in the investment market, with companies such as Hargreaves Lansdown heavily promoting his funds.

He left Invesco to set up his own fund, Woodford Investment Management, in 2014, and quickly built it to manage over £10bn at its peak. The current value it manages is now much lower, after its stellar first-year performance was not sustained.

What happened?

Typically, only a small proportion of a fund is held in cash: to beat the returns available through investing benchmarks like the FTSE All Share Index, you need to be heavily invested in the stock market and not hold money in low-risk cash.

One of Woodford’s institutional investors, believed to be Kent County Council, attempted to withdraw £263m from his fund. This followed a series of withdrawals from the fund in recent months, including over £500m during May alone.

Not having sufficient funds available in cash, Woodford needed to sell shares in order to cover the withdrawals – and that takes time. Woodford’s fund has a large proportion of illiquid holdings, which cannot be turned back into cash quickly.

The high levels of withdrawals also spook his other investors.

To stop a ‘fire sale’ of investors withdrawing their capital, which is like a run on a bank as we saw with Northern Rock after the financial crash in 2007, Woodford has suspended trading in the fund. That means investors cannot sell (or buy) their units, initially for a 28-day period, while he liquidates enough assets to stabilise.

Woodford isn’t the first fund manager to be in this situation, and he won’t be the last. But there are things that investors can take from the situation.

Investment lessons to take away

  1. All funds and portfolios go through ups and downs, this is part of investing.

Some comments have been made along the lines of ‘I didn’t expect my investment to fall 20%’. And that’s disappointing, because it shows people are fundamentally misunderstanding investing.

If you invest 100% of your money in the stock market, then you should expect the value to fall by up to 50% at certain periods of time. We’ve seen this during the dotcom bubble, during the financial crash… these periods WILL repeat themselves. We don’t know when, but they will.

If you expect it, you won’t be disappointed. Only invest money you can afford to tie up for a long period of time, and leave it to ride out the inevitable ups and downs.

  1. Diversification is your friend. It spreads your risk.

Woodford’s approach is to invest his fund in a very concentrated group of shares and companies. That gives you a chance of higher returns, but also increases your risk of a loss.

The portfolio includes only 105 different holdings in the fund, which is incredibly concentrated – and well over half of the fund (64%) is in just 20 of those holdings.

When your fund is concentrated like this, you only need one or two of its shares to do particularly well to see very strong returns. By the same token, you only need one or two to do very badly and your fund will pull back.

Woodford has had a tough time of it, with initial strong gains followed by retraction over recent years. It’s very difficult for fund managers to ‘beat the market’ – outperform the index funds that are available. Instead, you should focus on global diversification.

  1. Allocate your money carefully.

If you’re an active investor, diversification of funds is just as important.

I’m a proponent of index or passive investing, using an index tracker rather than using an active fund manager who is trying to beat the market. If you invest passively, you accept the market return and take the emotion out of the decisions of the fund manager.

But if you are an active investor instead, then don’t put all your money with one fund: allocate it across several and make sure it’s diversified globally, not only in the UK but across the US, emerging markets and Europe. At any given time, certain sectors won’t perform well, so make sure you’re allocating your risk. Never put all your eggs in one basket.

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