Does Woodford's failure have implications for other widely owned funds?

Thrugelmir

itwasntme001 wrote: »

Agree. Not at all clear what the catalysts are for the next leg higher in stocks and lot of headwinds are appearing. Perhaps a sign of a resumption of decent growth would signal a bottom in stocks. But no one knows for sure.

Globally, growth forecasts have been downgraded for the past 3 years. Given the correlation between major markets. Stock selection may become more important than indexes. When you learn that 16% of French manufacturing exports are for the German motor industry. The extent of inter dependence on certain sectors becomes very apparent. Climate change actions may have more short term impact than is currently appreciated.

Prism

The UK version of Fundsmith is currently £18.8bn in size and has a 59% 7 day liquidity. The Luxembourg version is 3.8bn euro's and has a 94% 7 day liquidity. I do wonder how big the main fund can get before the liquidity drops too much. Saying that I can 't imagine a situation where Fundsmith needs to dispose of half of its assets in less than 7 days.

Brian65

talexuser wrote: »

I think Woodford .....perhaps falling for his own hype.

Unless I'm missing something there is no perhaps about it.
Why else would Woodford have taken on Patient Capital with only a performance fee?

Thrugelmir

Prism wrote: »

Saying that I can 't imagine a situation where Fundsmith needs to dispose of half of its assets in less than 7 days.

LT have ended up in a situation where they regret holding Pearson across all their funds. Offloading their holding is only likely to crystallise even further losses. A catch 22 situation.

Prism

Thrugelmir wrote: »

LT have ended up in a situation where they regret holding Pearson across all their funds. Offloading their holding is only likely to crystallise even further losses. A catch 22 situation.

Possible. Fundsmith sold over $600 million worth of 3m stock during September this year and it had no noticeable effect on the share price. The problem with Pearson being in LT funds is that its basically a mid cap and would be harder to shift. There are a few UK holdings that probably shouldn't be in Fundsmith anymore due to their size vs its szie

bowlhead99

Brian65 wrote: »

talexuser wrote:

I think Woodford .....perhaps falling for his own hype.

Unless I'm missing something there is no perhaps about it.
Why else would Woodford have taken on Patient Capital with only a performance fee?

My take on why:

Listed private equity funds which will buy unquoted companies are hard to market to prospective investors without a conventional track record and a starter portfolio of assets that the investors can hear about before signing up.

Retail investors are generally not enthusiastic for asset classes they don't fully understand. Committing on a long term basis to investments which may not produce income and for which market prices are not observable until exits or partial exits can be achieved some years later, is a stretch for them. Therefore there needs to be some sort of sweetener in the prospectus for investors to get more excited about it.

Typically private capital funds will operate with a fixed management fee plus performance fee:

- If you do it on a performance-fee-only basis, you don't get revenue coming in during the quiet years to be able to pay the team's salaries and keep the lights on.

- While if you take a fixed fee regardless of performance (no performance fee), the management team's interests are not aligned with the interests of investors because they get paid just as much through good and bad. Meanwhile the talent you're seeking to identify and negotiate the private equity investment deals and exits will look at the performance fee / carried interest they could get at other private equity firms who would allocate the deal team a good portion of the performance fee if their deals are successful, and they would choose to work for those rivals instead.

So, management fee plus performance fee is market standard for some of the asset types in the portfolio. However, to provide liquidity as the portfolio builds, a portion of the assets were to be conventional liquid LSE-listed shares, and many of those shares would be expected to come from a shortlist of what the Woodford team had already identified as attractive shares in their more liquid open-ended products. As those assets would typically not be the sort of thing that attract performance fees in rivals' products, they could probably be management-fee only, and the management fee would not need to be very high if the asset selection process is going to borrow from what Woodford's listed equity teams have already researched and constructed.

From that, it would be reasonable for them to have a low overall fixed management fee plus the performance fee, the latter being the main thing which allows for incentivisation / alignment of interests, further enforced by the fact that the performance fee would be paid in shares of the trust rather than in cash.

When Woodford looked at that potential fee structure and the fact that he may need to offer a carrot, a sweetener, in the prospectus to get people to trust a new group with a limited track record, it seems that he concluded they should drop the 'low overall fixed management fee' altogether, and just keep the performance fee. After all, the purpose of a fixed management fee is primarily to keep the lights on and the salaries paid with some profit for the management company, and he had a multibillion fund on the side which was already generating enough revenue to cover the salaries and the lights and the profit.

WPCT was only planned to start at a few hundred million rather than a few billion, and they already expected to have management fees on the few billion they were managing, so half a percent of fixed management fee on the PCT would not move the needle by a massive amount for the management company in terms of monthly income. It was something they could afford to give up, as a sweetner for investors who were perhaps looking at the PCT with scepticis. Then they could really sell the story about it being a long term vehicle with everyone motivated to be in it for the long term, with rock bottom fees unless they made profits in excess of the hurdle rate, in which case they could charge for the performance and the investors wouldn't mind paying out of their spoils. An interesting structure and quite innovative when compared to conventional products.

I don't think that's an example of "falling for one's own hype". It's a commercially reasonable way to structure this type of fund's fee arrangements to motivate the management team and keep ongoing costs down for investors (esp. given many of the investments will not be cash generative, while holding cash in a fund for high running costs is a drag on performance).

The problem of course with a performance fee structure in a fund that falls well below the target hurdle rate for payouts, is that the fee no longer serves as a practical motivator - because the deal team could find several great deals that get huge multiples in a short space of time and still not catch up to the hurdle rate for decades.

When a new group come in to take over the management (whether as a going concern or a run-off project) you would expect them to reset the fee arrangements, and investors would be foolish to vote against. [/opinion]

Thrugelmir

Prism wrote: »

Fundsmith sold over $600 million worth of 3m stock during September this year and it had no noticeable effect on the share price.

Stock would have been placed with other investors off book. Using a multitude of broking houses. Selling stock in a firesale situation is a rather different matter.

Looking at the share price charts. 3m fell off it's high in April 2019. Fundsmith could have easily booked a 20% in value at the point of disposal in the period inbetween. Of course other investments could have compensated for the decline. The fall in share price shows how even the biggest company can soon disappoint and underperform.

Merely illustrates the difficulty in consistantly picking winners. The art is to pick more winners than losers to achieve an overall gain. No one ever maintains a 100% record. However successfull they are.

talexuser

Brian65 wrote: »

Unless I'm missing something there is no perhaps about it.
Why else would Woodford have taken on Patient Capital with only a performance fee?

To be fair he did try to shake up the industry a little. His 0.75% fund was below industry average fees on purpose, he gave monthly updates, and he did decalre all holdings as a norm rather than just the top ten. Pity his failure will not now spread reforms like these a bit further. The irony is his legacy might be the toothless FCA might do something about liquidity rules.

cloud_dog

I think it also highlights perhaps a not particularly well known or understood (to every day folk) risk in holding open ended funds; the inability to liquidate your holding should you choose to.

Thrugelmir

talexuser wrote: »

The irony is his legacy might be the toothless FCA might do something about liquidity rules.

I've tried to offload a small shareholding today ~ £7.5k. In a listed company with a market capitalisation of around £175 million. There's no market. No buyers. I've therefore had to place a limit sell order. Markets aren't as liquid as people might imagine.