Yesterday saw a classic case of someone trying to close the stable door after the horse has bolted. Let me hand you over to Bank of England Governor Mark Carney in Tokyo.
System-wide stress simulations are currently being developed, including at the Bank of England, to assess
these risks. And authorities are beginning to consider macroprudential policy tools to guard against the
build-up of systemic risks in non-banks.
That brings two initial thoughts. Firstly central bank stress tests have become a target of black humour as banks pass and then fail. Next why is he mentioning this?
Over half of investment funds have a structural mismatch between the frequency with which they offer
redemptions and the time it would take them to liquidate their assets. Under stress they may need to fire sell
assets, magnifying market adjustments and triggering further redemptions – a vicious feedback loop that can
ultimately disrupt market functioning.
If you had read this without seeing the title of this article you would probably be now suspecting where this is going but let me put this in a different way. As a concept the description above makes such investments sound like a bank which gets a liability asset mismatch via lending long and borrowing short. This is not something which has got much of an airing even in the credit crunch era. There was one past episode but it was presented as being exceptional.
We have recently seen analogous situations in the UK within some niche managers and smaller markets, such as open-ended property funds investing in commercial real
estate.
Some of you may recall the phase when after the EU leave vote in the UK several commercial property funds had a rush of redemptions and needed temporary freezes or closures. Now this should not have been any great surprise by the nature of the investment as one can hardly sell a shopping centre quickly, so this was a known issue for this area and a reason to avoid it if you fear that. Some institutional investors I have dealt with are very careful they can get out of an investment before they get in. To give you an example of a past issue along these lines was a couple of decades ago when there was a fashion for investing on the Milan stock exchange. You see it later transpired it was a lot easier to get your money in than it was to get it out!
However conceptually Governor Carney suddenly seems to have released this is in fact a much wider problem.
These flows are particularly flighty , reflecting the fact that more than $30 trillion of global assets are
held in investment funds that promise daily liquidity to investors despite investing in potentially illiquid
underlying assets, such as EME debt ( EME = Emerging Markets )
What has triggered this?
From the BBC on Monday.
One of the UK’s most high-profile stockpickers has suspended trading in his largest fund as rising numbers of investors ask for their money back.
Neil Woodford said after “an increased level of redemptions”, investors would not be allowed to “redeem, purchase or transfer shares” in the fund.
Investors have withdrawn about £560m from the fund over the past four weeks.
Kent County Council also wanted to withdraw its £263m investment, but was unable to do so before trading halted.
There have been various issues here. The opening one is that Neil Woodford was an extremely successful fund manager meaning that when he went alone a lot of money was invested in his funds. However more recently his investments have lost that magic feeling, we looked at Provident Financial for example a while back and Purplebricks was another. As it happens Monday brought more trouble on that front.
Mr Woodford’s firm, Woodford Investment Management, is also the biggest investor in Kier Group, the construction and services group which on Monday warned on profits, sending its shares crashing 41%.
Obviously there is an issue of selling into falling markets but there is a deeper one which is the way that there were investments in illiquid ones. There is a limit of 10% for this in OEICs or Open Ended Investment Companies a boundary which was approached and this causes trouble as a fund shrinks. If you sell the liquid shares then the illiquid ones grow in relative terms and things become more unstable. What could go wrong?
Financial Conduct Authority
You might be wondering what our regulator has been doing here. On Tuesday Andrew Bailey was interviewed by Bloomberg TV and this is how they summarised it.
FCA CEO Andrew Bailey says they are “closely watching” Neil Woodford’s fund plans
I would imagine that pretty much everyone is thinking they look to have been asleep at the wheel. But if you watch the interview he made the statement that it is better that illiquid assets are in the non-bank world than in the bank world as we wonder if a game of playing pass the parcel has been taking place? Banks are “resilient” because the problems have been moved elsewhere?
Care is needed with this we do need investment in things which are illiquid such as new start-ups. So this in itself is not the problem to my mind it is that the risks should be made clear. On that road the FCA has been asleep because income funds have been considered low risk whilst in fact being allowed to run a high risk strategy. Putting that another way someone might consider them as being a fund for close to and at retirement when we now see that can be simply untrue.
There has also been another problem. From Reuters.
The FCA indicated on Wednesday that it was concerned the movement of some or all of Woodford’s stake in four companies to Guernsey might be an attempt to side-step rules capping the share of unlisted stocks in his fund at 10%.
Where was it when this was happening? It now seems to be engaged in a bit of tit for tat finger pointing with the Guernsey authorities along the lines of this from Lily Allen.
It’s not fair and I think you’re really mean
I think you’re really mean, I think you’re really mean
Comment
There is in my opinion something missing from the debate and well might the Bank of England look away from this. It comes if we look back and take a once in a lifetime opportunity to ask this question.
You may ask yourself, “Well, how did I get here?”
Seeing as it along with the other central banks has chopped interest-rates and yields via all the reductions and bond purchases they have crippled the old concept of investing for income. It was only yesterday we were observing that Germany has a benchmark yield of -0.23% and the UK Gilt equivalent is 0.86%. So how do you offer a yield of say 4% plus a capital gain? Plainly you have to take more risks than in the past.
There is an irony as we note the role of “The Precious” here. There was a time when in the UK the banks offered what was perceived as a safe dividend yield ( younger readers I am asking you to trust me on this,,,,,) and were a staple of this sort of investing strategy. Not only has that gone but the consequences of that is the low,no and negative yield world in which we now exist.
So the people who are supposed to protect us are the ones who in fact have contributed to the problem as we ask one more time.
Quis custodiet ipsos custodes? ( Juvenal)
In the interests of full disclosure I wrote a piece for the Woodford blog a few years back predicting that the next move from the Bank of England would be an interest-rate cut.
Notayesmanseconomics's Blog 
Hi Shaun, I think it is the unreliable boyfriend stating the “Bleedin obvious” again. I have more than £250 in my current account but when I go to the cashpoint I can only get that much.
Like any market event, if everyone rushes for the door simultaneously then no one get get though it. The fools are the people who give money to woodford and think they can get a redemption, his terms and condiitions will state that such things are controlled.
We know its a ponzi, there is just so much ponzi, it is difficult to know who anyone will leave with their clothes on and its worth noting the CB’s have created this ponzi.
Bonds
Equities
Property
Secondary leveraged indicies-based products
Just imagine if the baby boomer cohort were, as if by magic to all die with a short time of one another… What would happen if all of thos over-priced properties came to market simulatenously by the inheritors “cashing in” ?
🙂
they’ll go to the Halifax and asked them to pump up the market…..
I really have no faith in their index at all – perhaps I need 1/2 lb of what they are smoking !
Forbin
😉 I understand that you are cashing early anyway Forbin. How is the market in Surrey?
selling my late father’s property
estate agents ( spits to ground ) kept saying it worth xxx and then cannot get it , then wheedle on about dropping price , so you follow their advice ( for all, note that they will give you a high price to get you in , then after the 2 week cooling off period they put pressure on to drop to what could be a realistic price , but still might not achieve) ……
I’d say 10% down from last year
and dropping , looks like back to 2014 prices
so this is a round-a-bout result for me as obviously I’d like a good price to give to my son so he can move out , but he needs lower prices to afford the mortgage.
I’d side actually with lower prices but some would not.
Like Mark Carney 🙂
Forbin
Forbin, I understand. Getting ahead of the market to make a sale is tricky, as you say because the Estate Agents are incentivised to both dream of better valuations, the prospect of finding a dumb overpaying buyer and the higher % fee therein. But of course they will admit to realism in prices once they fail the your first calendar period, but at the same time resent any fall because they are doing “market clearing” and shooting themselves in the foot at the same time.
We only want growing values, in everthing, so much easier to manage.
Lets print some more money.
Paul C
You are of course correct nothing is safe when all rush to exit the door if its not slammed shut quickly capital can be eroded fast.
Invesco has distanced themselves from Neil Woodford interestingly a number of Invesco funds much smaller now since Woodford left.
https://www.ft.com/content/7264d3c0-8871-11e9-97ea-05ac2431f453
The public need to realise if the balloon did burst big time and it may do due to growth fuelled on debt all would suffer.
Much has been talked on this forum about various governments will do all they can to prevent a further financial crisis but in truth there is only so much they can do and most economists think there will be another one at some point in time.
Weak job figures were confirmed today from the US and wage inflation was weaker as well. Earlier industrial production fell -1.9% in Germany and the Bundesbank downgraded Europe growth from 1.6% to 0.6% that is a hefty downgrade.
UK gilt yield fallen again 2 to 0.50%
https://www.bloomberg.com/markets/rates-bonds/government-bonds/uk
Lots of red flags waving the public would do well to take notice. Unfortunately fear can drive more fear and a meltdown can rapidly escalate nothing is secure we come into our lives with nothing and we take nothing away!
Hi Shaun, a belter as usual, I thought this was the intended consequence of QE, to push saving yields low and so into the real economy which would boom with all the money pouring in. Now you’ve pointed it out so starkly, it seems obvious that what pours in will one day pour out.
As I have long argued ‘The Precious’ have taken their eyes off the real economy and focussed on other asset inflations such as property. We need a National Investment Bank which could easily be created by nationalising RBS. It’s time to focus again on what reallyu matters.
Hi Bill,
I have long argued that TPTB have always though of the Banks and Financials as the economy !
Politicians are looking after their own self interest – well paid jobs in the city to retire too …..
Forbin
You have to admire Mark Carney and Andrew Bailey.
No, honestly, I mean that – they are up to their necks in a massive sh*t storm that they themselves have created and yet their current and future employers all think they smell of roses and are worth every penny they don’t earn.
and to cap it all , they’ll end up with a Knighthood too !
Forbin
PS: yup, George was right , it’s a club , and we aint in it !
DD. My downtick, sorry. I should not try navigating Shaun’s blog on a tablet. Too easy to touch something by mistake.
Thanks for letting me know, I was wondering if Mark himself had stumbled on my comment!
Hi Shaun
Thankyou for keeping the old grey cells ticking over.
The list of things not to invest in seems to be growing.
!) Shopping centres
2)Out of town shopping complexes.
3) Investment funds
4) Most equities
So all funds and many local councils hungry for growth
are investing in most if not all of the above potentially
socializing future shortfalls.
Lunatic fringe
In the twilight’s last gleaming
But this is open season
But you won’t get too far
‘Cause youve got to blame someone
For your own confusion
We’re on guard this time
Against your final solution
JRH
Well any kind of shop really, high street and retail centre… oh and any kind of UK car manufacturing plant of supply chain business too…
buying shares in things like Uber and Lyft seem to risky beyond belief …… so lets pile in guys !
what could go wrong ?
the tax payer will bail us out ……….. again again again
musik link
Forbin
Hi Shaun,
Great article as usual. I know Neil Woodford and his fund pretty well. In my view, there are a multitude of sins here, especially in his biotech investments, which feature heavily:
1. Everyone knows that biotech investments are highly specialised as well as illiquid. That is why the venture funds all have ten-year lives or are evergreen without redemption rights from underlying investors. Even when they make payouts to the investors, they distribute the underlying biotech stock rather than give them cash unless the business is sold for cash;
2. It is my experience that his funds do almost no due diligence compared with professional VCs. Anyone could have told you to avoid, say, Circassia, with its allergy “franchise” which, to no-one’s surprise in the sector, failed utterly;
3. Corporate governance is very poor. For example, the CEO of Circassia (where Woodford is the largest shareholder) is the chair of the audit committee of one of Woodford’s other funds, the Patient Capital Trust. Do you think that he will rock the boat?
I could go on, but it all boils down to the fact that his fund is full of illiquid stocks. Some are claimed to be going public within a year, presumably to enhance their liquid status, when everyone knows that an IPO cannot be guaranteed. The fund is supposed to be for the long term, but its redemption structure is inappropriate for holding illiquid stocks and the main fund has now announced that it will sell all its illiquid stocks down to zero, something that may not help their value…
A sad story.
“it all boils down to the fact that his fund is full of illiquid stocks…”
indeed , the TBTF Banks though , have stock that’s unicorn in nature……..
I suppose that’s kinda ” illiquid”…… eheheheheheh
Forbin
I have just had another look at the illiquid stocks in his portfolio again. In March, the (now suspended) equity fund transferred £79 million of unquoted assets at “valuation” into another of his vehicles, the Patient Capital Trust. This Trust stands at a big discount to NAV, but the equity fund took shares in the Patient Capital trust at NAV, thereby:
1. Guaranteeing a loss for the equity fund holders
2. Creating liquidity out of thin air, as the Patient capital trust is listed and therefore now is liquid as far as the equity fund is concerned.
The astonishing (I mean astonishing) rationale for taking the NAV, rather than the quoted price of the Patient Capital trust, is that the equity fund would not have been able to buy £80 million of shares in the Patient Capital trust at the current share price, so this was OK. As though the equity fund would ever do that!! Meanwhile the Patient Capital trust sent out a gloating press release saying that it had raised the size of the fund at above the current share price…
I would say that this is as close to smoke and mirrors as you can get. What could possibly go wrong?
ok so I guess he “Made off ” with the money ?
ummm
Forbin
Hi Shaun
Great article as always. But why is the FCA getting invloved? Surely investing in shares is a risk (which I accept), but then again we live in an age where no-one is financially responsible and its always someone elses fault. In fact I heard a PPI style ad on the radio asking for people who had lost money in ISA’s. Do you think I can get a rebate on some dodgy AIM shares I bought in the noughties 😉
As always they seem to be alsleep at the wheel, and are surprised when scams like this happen:
https://www.bbc.co.uk/news/uk-england-47454328
Also this is a direct response to keeping rates on the floor for over a decade. People are investing in dodgy areas just to get a yield, and another one bites the dust:
https://www.cityam.com/uk-peer-peer-finance-company-lendy-collapses-amid/
Lots more peer to peer lenders are on the brink apparently. I’m pretty sure it was the FCA which approved peer to peer lending to be included in ISA’s?
More mis-selling on the horizon?
Hi Anteos and thank you
On that theme maybe my I could put in a claim for the BES scheme that my late father invested in! But the issue here is the crony/regulated capitalist world in which we exist. The regulators have their own mission creep as they expand their empires and we also have a situation that the establishment is determined to keep the blame away from their own actions.
Even worse when those at the top ( Northern Rock, RBS) have all sorts of arrows pointing at them nothing major happens. Also I have a friend who is an IFA who put some of his clients investments in a fund whose name I cannot recall. The directors put out a misleading prospectus which he had no way of knowing. Yet he had to pay some compensation whilst they just strolled away. The only thing he was guilty of was being lied to.
As to the peer to peer lending issue it will be a “surprise” that “could not possibly have been expected”
Questions:
“Hargreaves Lansdown chiefs in £6m share sale: High-flyers cashed in weeks before Woodford crisis sent stock tumbling”
What did they know?
https://www.dailymail.co.uk/money/news/article-7113229/High-flyers-cashed-weeks-Woodford-crisis-sent-stock-tumbling.html
Hi Peter
The headline gives the impression they sold shares in Woodford, which would be an issue as they were pushing it as an investment. However, whilst Hargreaves was affected unless you had actual proof they knew about Woodford it could just be a share sale.
Yes it could have just been a share sale, but the amount sold and the timing raises concerns.
I’m not sure QE is to blame as such if we’re looking for a starting gun. Surely the starting gun if unfettered, unbalanced globalised trade and free global capital flows.
This fact alone allows for vast quantities of liquidity to build up and then to flow around the world seeking yield. I liken it to the aptly named “Herald of Free Enterprise” – the capsized Ro-Ro ferry, that failed because of the lack of septa to control the sloshing of the liquidity in its ill fated hull.
QE is merely a response to this issue. Replacing liquidity with even more.