Rebuilding trust

The Woodford scandal has raised concerns about the measures in place to ensure effective management of investors’ money. Few would argue against the investment sector being built on trusted oversight – but those close to it acknowledge it has some way to go

It was the fund implosion that no one saw coming but perhaps should have. When investment management superstar Neil Woodford closed Woodford Equity Income last June, several hundred thousand investors were left wondering how such a collapse could have happened.

Not only was Woodford one of the most recognisable names in investment management, but his track record was also one of the best.

Yet the Financial Conduct Authority (FCA) mantra that ‘past performance is no guide to the future’ exists for a reason. Just because Woodford was once gifted with the golden touch did not mean he always would be. Investors were certainly given a sharp reminder that nothing in the world of investment is certain. 

But Woodford’s fall from grace also brought into sharp focus the sometimes-shaky governance foundations on which fund management is based.

What went wrong at Woodford raises questions about oversight throughout the fund management system. 

And, given the series of global financial crises that have plagued the markets since the turn of the century, an effective investment management sector has never been more important.

Andy Agathangelou, Founder of the Transparency Task Force, says: “The world needs an investment sector that can be trusted; and the evidence suggests we’re not there – yet. Effective fund governance is an absolute prerequisite if the sector is going to deliver on its true potential as a prudent steward of the world’s capital markets.”

He adds: “While there is a great deal of best practice around that’s being authentically applied in the interests of investors by many funds, the challenge is to get all funds to be governed to a sufficiently high standard. Calling out poor practice will help.”

Independent oversight

In the case of Woodford Equity Income, best practice appears to have been sorely missing. The fund was unable to cope when large numbers of investors wanted to withdraw their money following poor performance. However, the fund had invested significant sums in illiquid assets, which meant that investors could not realise their assets and many lost thousands of pounds.

But why was an equity income fund investing so much in illiquid assets in the first place? And why did the fund’s authorised corporate director (ACD), Link Fund Solutions, which was supposed to act independently and in the interests of investors, fail to intervene?

The ACD’s role is to represent retail investors who may have little means of having their voices heard in the running of the fund. 

Since September 2019, the FCA has tightened the ACD governance, insisting that two non-executive directors sit on ACD boards to ease conflicts between the board and investment manager, and challenge decisions on behalf of investors.

Jon Beckett, a Director of the Association of Professional Fund Investors and an independent non-executive director (INED) at an asset manager, says: “It is through the appointment of independent non-executive directors to fund boards that customers can look to gain some fund insight. INEDs are the customer champion and are there to represent fund holder rights.”

While this looks like a robust way of protecting investors, the governance starts to look a little unsteady when it becomes apparent that, rather than the ACD appointing the investment manager, it is in fact the other way around.

It was Woodford who appointed and remunerated Link Fund Solutions, and it was he – or at least his asset management firm – that had the power to sack the ACD. 

For all its apparent oversight, the only thing Link could do in the event of malpractice was raise concerns with the regulator or step down. 

Bill Prew, CEO of depository INDOS Financial, says such a situation gives rise to significant conflicts of interest, which undermine the checks and balances designed to safeguard investors.

“The Woodford [collapse] raises broader questions of alleged conflicts of interest,” he says. “People are asking if [ACDs] can act independently and in the interests of investors. The regulators are looking at that.” 

Link Fund Solutions was not the only player supposed to be protecting investor interests. Northern Trust was the depository for the Woodford fund and was tasked with safekeeping assets and monitoring the ACD. 

Northern Trust is currently being investigated by the FCA for its response to the level of illiquid assets held by Woodford, which at one point had an 18% allocation. The legal maximum investment in illiquid assets for such funds is 10%.

Beckett believes that the current governance system does not encourage effective communication between key stakeholders and is reactive rather than proactive. “There are times when [depositories and ACDs] don’t talk to each other enough; issues aren’t raised to the correct board and committee before things go wrong,” he says.

Communication breakdown

In the Woodford case, it was only once the illiquid asset limit had been breached that any party started to raise the alarm. 

In their defence, depositories argue that they may not be heard. Roberta Robustelli-Diederich, Director for Depositary, EMEA Alternatives, at Sanne, says: “The depositary’s request should be taken more seriously from fund parties, and regulators should enhance this message to managers, initiators and fund accountants.”

While there are inherent flaws in the ways in which stakeholders interact, Beckett also raises concerns about the way in which mistakes are dealt with. 

When savers and investors lose money, they are repaid – up to £85,000 – through the Financial Services Compensation Scheme (FSCS), which is funded through levies from providers and advisers. 

Beckett argues that this does not share the burden of blame equally across the industry. There has been an increase in advisers leaving the industry, driven out by rising levies and insurance premiums. 

He adds that the compensation response further undermines governance. If advisers are being forced out of the market, they will not be readily available and affordable to the man or woman on the street when it comes to making a good decision.

“Currently, the system shares the pain of malfeasance across the whole industry but not necessarily proportionately,” says Beckett. “So advisers are struggling to meet their levies. It feels like the system needs a really good shake-up.”

As the Woodford scandal trundles through the legal system, and disgruntled investors await their FSCS payments, there is an opportunity to tighten up fund governance.

Regulators have rightly focused on protecting investors following the devastation of the 2008 global financial crisis, but there are obvious flaws in the existing system that need further attention.

If investors are to regain their confidence, the cornerstones on which fund governance are built must be reinforced – before another Woodford undermines the whole structure.