Neil Woodford’s back – but sometimes sorry isn’t enough

“I’m very sorry for what I did wrong,” former star fund manager Neil Woodford tells The Sunday Telegraph’s Lucy Burton. It’s less than two years since his fund management business collapsed. That happened because a) he was underperforming and b) when investors got fed up with that, and jittery about some of his other holdings, and went to withdraw their money, it turned out that he was too heavily invested in stocks that couldn’t be sold in a hurry. As a result, his funds were frozen. The ensuing firesale of illiquid (defined below) assets compounded the losses investors had already suffered. Many are still waiting for money to be returned. Now he hopes to make a comeback – hence the “tearful and defiant” broadsheet interview.

What does history suggest about penitent fund managers? Investment platform Interactive Investor compiled a list of five UK managers who’ve felt the need to apologise to investors in the past, and looked at what happened next. Anthony Bolton, who was almost as famous as Woodford, retired on a high in 2007 from Fidelity Special Situations. He returned in 2010 to head up Fidelity China Special Situations, but dented his reputation with a weak performance (and unusually high fees). He apologised publicly in 2011, but by the time he re-retired in 2014, performance was still nothing to shout about (though the fund went on to do well – and trimmed its fees).

Sorry, but...

It’s a nice story. But it’s not really relevant here. Woodford is on a very different scale to Bolton, or any other manager on Interactive’s list. All active managers – even the few who seem to beat the market consistently – underperform sometimes. But outside of commercial property funds (where the clear conflict between the daily liquidity of open-ended funds and the illiquid nature of the underlying asset has resulted in regular freezes and belated regulatory attention), Woodford is unique in presiding over this kind of disaster.

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Yet that’s not what he’s sorry for. He’s sorry for “two years of underperformance”, but, he tells Burton, “I can’t be sorry for things I didn’t do. I didn’t make the decision to suspend the fund”. That’s pure denial. Regardless of others’ errors, it was literally Woodford’s name over the door. The buck stops with him. It’s not as though he couldn’t have known the risks that go with illiquidity. Yet the only person he sounds genuinely sorry for is himself. “I don’t want to go into details, but retail investors were not the only people who suffered financially,” he says. His new firm, WCM Partners, will work with Acacia Research, which bought stakes in several life sciences firms in the firesale from Woodford’s old funds. If it’s a sector you like, stick to Syncona (LSE: SYNC) instead.

I wish I knew what liquidity was but I’m too embarrassed to ask

Put simply, liquidity refers to how easy it is to buy or sell an asset without moving the price against you. For example, property – both residential and commercial – is an illiquid asset. It takes a long time to buy or sell, trading costs (from stamp duty to surveys) are high, you can never be quite sure of the price you’ll get (or pay) until the deal has closed, and if you want to sell in a hurry, you’ll have to cut your price to well below the theoretical “market value”.

On the other hand, shares in big, listed companies (“blue chips”) on the FTSE 100, for example, are very liquid. They are also “fungible” – ie, one share is the same as another, whereas each property is unique – so millions can change hands every day online. You can get a price almost instantly, and you can almost always find a willing buyer or seller, even in turbulent financial conditions.

The level of liquidity in a market can vary widely – for all but the most liquid assets, it’s wise to assume that it will dry up at the worst possible times. In times of turmoil it may even evaporate altogether. For example, one big problem in the lead up to the 2008 financial crisis was that liquidity in the market for securities backed by subprime mortgages dried up entirely, and the securities were essentially unsellable.

Stocks in smaller companies can also be highly illiquid – when the market is volatile, the “spread” (the gap between the price at which you can sell and the price at which you can buy) might widen sharply, making trading more costly. Indeed, in the very worst panics, only “safe haven” government bonds, such as US Treasuries and UK gilts, may remain as liquid as they usually are.

Illiquidity is not in itself a problem. You usually get paid more to hold illiquid assets. The real problem only arises when you own an asset that turns out to be a lot less liquid than you expected – for example, if you own a fund that promises daily liquidity, yet holds a portfolio full of barely listed stocks.