A Misalignment of Interest
The title of this piece refers to a misalignment of interest often also described as a principal/agent conflict. The principal is the investor and the agent is the asset manager. The investor wants to preserve and grow their capital in real terms while many agents, especially publically-quoted asset management companies, want to gather assets and retain them, often by managing and referencing those assets versus an index benchmark. This might be fine in the large-scale institutional world but is an index relevant to individual investors?
We have spoken to the regulator previously about not treating a product range built for large institutional investors as suitable for all investors. The resultant indexation fixation has been of little help to the individual investor who generally seeks an outcome – one they can understand – in preference to referencing an index. While the industry trade body, the Investment Association (IA) has attempted to help, having over 3,500 funds in over 30 sectors hasn’t been too helpful. Not when one of those sectors, the Unclassified sector, hosts around 350 funds or approximately 10% of the total number of funds. At least the FCA is attempting to standardise benchmarking references for funds in its Policy Statement PS19/4 due to take effect from the 7th of August this year.
Most agents run their asset management businesses proliferating products based on asset class and geography but is that right for all investors? That might suit the consultant driven institutional market who invest through a similarly styled asset allocation but does little for the retail investor.
Value for Money
This subject has provided scope for a lot of debate not least with the regulator. In reality, value for money should be defined as risk-adjusted returns after fees relative to a fund or portfolio’s investment objective.
There has been much press coverage concerning the trend towards wealth managers using segregated mandates. The concept here is that they can either get the strategy cheaper or tweak it to be more bespoke. Often the concept is to get access to a fund strategy at a cheaper price due to the size of the mandate they are offering the fund manager but that begs the question: if as a fund manager, you are focused on performance over asset accumulation, why give your capacity away cheaply? Fair enough if you’re getting started and need to reach a critical mass but as many of the fund managers T. Bailey invests with have their own money invested in their funds, they won’t want to compromise performance by running too much money. In short, the cheaper fee seeking intermediaries acting on behalf of the principals are exchanging larger pools of assets in return for lower fees.
Agents, whose primary motive might be asset gathering, force the principal, either consciously or subconsciously, into strategies with abundant capacity like large-capitalisation equities constrained by an index.
In the course of putting this piece together, a notable event occurred in UK asset management; the suspension of dealing or ‘gating’ of one its most popular funds, the LF Woodford UK Equity Income Fund. While not too long ago, daily priced property funds were gated for liquidity reasons*, this suspension of dealing is the first we can recall of a long-only equity fund. Neil Woodford has been feted as a ‘star’ fund manager – a term we dislike. ‘Stars’ can have too much power which might compromise good governance. However, Woodford had clearly, over a long period of time, demonstrated his skill in delivering good results but in recent times investors have lost faith. The catalyst was apparently a large institutional investor firing Woodford as its investment manager and Woodford, who had been suffering redemptions anyway, was unable to meet further redemptions due its holding in illiquid investments.
Following the unfortunate announcement of the dealing suspension, one of the UK’s largest wealth managers announced that it had fired Woodford from managing its segregated mandates amounting to a few billion pounds.
It is not beyond a simple rationale that a large publically-quoted investment company might be able to accumulate assets more readily if they use ‘star’ managers who might have assumed cult-like status among the investing public. That’s not for us to say but I’m fairly sure that most investors are understandably unhappy about not being able to access their money and hadn’t contemplated that when they invested. Other wealth managers subsequently followed suit. Share prices of quoted wealth managers that held Woodford Funds have responded unfavourably.
On Thursday morning of the same week, a day and a half after Woodford’s landmark decision to gate his Equity Income fund, a leading rating agency downgraded that fund to a negative rating. Hardly ahead of the game but highlighting the fact that rating agencies might not be the best help for investors.
Should shareholders rank before investors? Are some investment managers in fear of getting it wrong by being judged for being behind an index? Does institutional thinking suit individual investors’ needs? Probably not. Stop and think for a moment – why does an investor care about an index?
Why not invest with outcome-based aligned investors? They’re out there.
*To appeal to investors who might be uncomfortable not being able to access their property fund investments on a daily basis, many investment firms offered daily liquidity. This clearly represented an asset/liability liquidity mismatch so when there was a down turn in the commercial property market in July 2016 after the UK referendum, redemptions couldn’t be met and funds gated. We know of one fund that maintained a cash position of between 15-20% to deal with flows. They charged a fee based on 100% investment – an obvious misalignment of interest.
T. Bailey’s philosophy is based on a belief that investors want to:
- Preserve capital
- Grow their wealth in real terms (i.e. above inflation)
- Be conscious of downside limitation
We used to have fund managers try to appeal to us with the following statements:
‘We run £682 billion in asset under management’
‘The market was down 21% but we only lost 19%’
Our response – ‘You’re too big to extract the returns that we seek and you have the wrong mind-set – there’s no alignment of interest.’
NB – T. Bailey Asset Management have not held any Woodford funds for over two years after a position held in Patient Capital Trust, an investment trust, rose too sharply to a substantial premium post its initial public offering and we sold our position on valuation grounds.