Pay attention to your funds

The thousands of investors who have been prevented from taking their money out of the fund since last June were told that, depending on the types of shares they held, they would be looking at receiving between 46.3p and 58.9p per share.

But this is also dependent on whether they were accumulating their returns or receiving income, and who was distributing the fund.

Across the board, it meant a loss of between 20.8 per cent and 43 per cent of their investment, according to Jason Hollands, managing director of Tilney, and again that figure depends on whether they invested at the fund’s zenith in June 2017 or at another time.

While the fall from grace for Mr Woodford has been dramatic, there are many other funds that are not as liquid as their investors think they are

That may not be the full extent of their returns though, as some illiquid assets are still in the process of being divested and there may be more to come.

That is the difficulty with illiquid assets: they take time to realise and if there is a run on the fund, as there was with the Woodford Equity Income Fund, the only option you have is to suspend the fund.

That causes more panic among investors who previously were perfectly happy and has the potential to bring about its overall downfall.

While the fall from grace for Mr Woodford has been dramatic, there are many other funds that are not perhaps as liquid as their investors think they are.

In fact, the European Securities and Markets Authority has raised this specific issue in its latest survey of alternative investment funds, released in January.

This sector was worth €5.8tn (£4.9tn) last year based on net asset value, accounting for 40 per cent of the overall EU fund industry.

Fund-of-funds – a favourite for retail investors – amounted to 14 per cent of the overall amount of the industry, with real estate funds accounting for 12 per cent, and hedge funds and private equity funds each worth 6 per cent of the overall figure.

However, Esma very specifically pointed to the liquidity risk associated with fund-of-funds and real estate, which had the highest proportion of retail investors who may have little knowledge of the increased risk they are taking with their investments.

In the report, Esma highlighted that 31 per cent of fund-of-funds investors were retail, while 21 per cent of real estate fund investors were retail.

More worryingly, it stated: “Many of the funds in the real estate sector offer daily liquidity, which indicates a structural vulnerability risk as they invest in illiquid assets while allowing investors to redeem their shares over a short timeframe.

“For the funds-of-funds sector there is a mismatch in liquidity, as 35 per cent of the NAV is redeemable within a day, while only 24 per cent of assets can be liquidated within that timeframe.”

Remember, this is Esma talking here. If investors are not aware of these liquidity issues, they could be taking more risk with their money than they think.

Advisers should have a better handle on this and be offering advice to investors based on this as one of the aspects of risk to consider.

This is the kind of thing clients must understand before getting into these funds, especially in the wake of the Woodford issues.

While it is clear more than 70 per cent of the fund-of-funds are open-ended, at the other end of the scale is where you see the liquidity mismatch, according to Esma.

But what may be an additional concern is that fund-of-funds have a large amount of their investors’ money in funds from the same manager, amounting to 38 per cent of all fund holdings the report outlined.

If one fund manager goes out of fashion for some reason then the fund-of-funds exposure potentially becomes an issue.

I spent many years reporting on the split capital investment trust scandal, where the ‘magic circle’ (as it was known) invested heavily in each other’s funds, resulting in inflated values that could not be sustained in a downturn.

Is this approach from fund-of-funds managers tantamount to the same thing?

I hope not, but it is not something that anyone looking at the real risk they are taking with their money can ignore.

There is an argument that to drive the car you do not necessarily need to know exactly how the engine works best.

For many investors I can understand this is the case with their fund investments.

As long as they get the job done, they probably will not be overly worried about how it happens – although they will always want to know they are getting value for money.

However, rather like the car analogy, if a crash comes I really do want to know that the airbags are working and will save me from serious harm.

So, perhaps it is time to check the airbags on these funds a bit more closely, ready for the next downturn because, inevitably, it will come.

Alison Steed is a freelance journalist