Woodford: 10 questions the FCA should ask

In the fallout from the Woodford debacle, there are a several questions that the FCA should be asking over coming weeks.  Some technical, some compliance-related, and some propositional.
Here’s my checklist:
Start with the KIID.  The stated objective of the Woodford Equity Income Fund (“WEIF”) is “to provide a level of income together with capital growth.”  The stated policy is “to seek to invest at least 70% in shares of UK listed companies. It may also invest in unlisted companies, overseas entities and derivatives. It is not anticipated that the use of derivatives will have a significant adverse effect on the risk profile of the fund.”  So investors who read the KIID (which is meant to be all investors) understood that the fund would invest in unlisted companies.
Look at the factsheet: the stated objective on the factsheet of the WEIF is “To provide a reasonable level of income together with capital growth. This will be achieved by investing primarily in UK listed companies.”  Given most investors check factsheets, not KIIDs, why was there no reference to unlisted assets on the factsheet.  A small point, but, in my view, the objectives as stated on a factsheet and KIID should be identical verbatim.
Was there mis-selling? Arguably not.  The reference to unquoted assets is right there in the KIID, and implicitly in the word “primarily” on the factsheet.  And Woodford published all his holdings.  So caveat emptor.  But the trade-press and some brokerages focused much more on his large cap investment style than his unquoted investments, until they started turning sour that is.  So any mis-selling discussion would need to focus on the nature of the financial promotions issued by Woodford and to what extent they outlined the extent of the allocation, and associated risks, with illiquid assets and how the fund’s strategy was presented to potential investors.
Promotional materials: brokers offering the Woodford fund articulated his style (presumably based on Woodford’s own promotional materials) as investing in big solid companies with stable dividends.  There’s little or no reference to unquoted assets, so is it possible that investors (who rely more on buy lists and trade press) were unaware of the risks associated with illiquid assets.  So investors were possibly exposed to more risk than they were expecting.
Are there any similarities between the issues that arose for WEIF and the issues that arose with Invesco Perpetual?  The FCA published a damning 29 page verdict on the breach of limits by Invesco in relation to funds (including two flagship funds managed by Woodford), shortly before he left the firm.  You can read the full report here.  But to summarise, the issues in 2014 focused around “1) investing some of its funds in breach of investment limits; 2) introducing leverage into certain funds without providing investors with and 3) failing to put adequate controls in place to ensure that all funds were valued accurately and that all trades were allocated fairly between funds.  As a result of these failings, Invesco Perpetual’s investors were exposed to greater levels of risk than they had been led to expect.” Were similar issues arising at Woodford, and if so, who was responsible – any or all of the management firm, fund administrator, or the fund manager?
Limits for illiquid assets: to what extent did Woodford breach either in letter or spirit the rules around maximum holdings in illiquid assets for a daily dealing fund?  In early March, the holdings in illiquid assets hit 18%.  The two steps that will come under increased scrutiny were 1) the asset transfer of unquoted shares to WPT (where such investments are more appropriate) which, amazingly the manager, claimed after taking legal advice that “the shares-for-assets deal was not a related party transaction”, and 2) the attempt to list assets on TISE to get round the letter of the rules.
Compliance turnover: there has been a high turnover of compliance officers (those with the controlled function CF10 (Compliance Oversight)) at Woodford Investment Management and its predecessor firm Woodford Investment Management LLP.  Having three compliance officers in five years, according to the FCA register for those firm, raises its own set of questions.
Role of buy lists: in the non-advised sector, buy lists are helpful for investors who feel overwhelmed by choice and want help in selecting funds for each asset class.  Some brokerages offer their own buy list, like the HL50, others offer their own buy list alongside third party research from fund rating firms like Morningstar.  Buy lists provide an important resource, but will come under scrutiny.  Screening methodology, impartiality and oversight should be clearly defined and implemented.  Nor should buy lists be restricted to active funds.
Investor behaviour: ironically, behavioural research points to investors often being their own worst enemy.  Chasing star managers, or star asset classes (before a fall), not cutting losses early enough, over-relying on brands and personalities and not managing a broader asset allocation are all well documented failures.  Looking at behaviourally-adapted investment propositions, such as target-risk or target-date multi-asset funds, is one potential remedy.
Need for kitemarking: there is an overwhelming level of choice of funds for retail investors, both for single-asset strategies and multi-asset strategies.  Investing an entire portfolio into a single asset class – like UK Equity Income – is rarely likely to be appropriate.  And the biggest detriment to customer outcomes will be those investors who have all their wealth held within a single asset class and within a single fund.  There needs to be a discussion around the potential role for investment pathways (not crossing into advice) that use kitemarked multi-asset funds that are outcome-oriented and evaluated against stakeholder-style metrics including good customer outcomes and value for money.  In the US pensions market, safe harbour criteria give providers comfort that they are not giving advice when selecting a default strategy for less engaged, less confident investors.  Kitemarking would be a possible first step in this direction.
 
The views expressed are the author’s own and do not necessarily reflect the views of Elston Consulting Limited, its clients or suppliers.