As the fund management industry comes to terms with the Woodford Equity Income Fund debacle, says Kavita Patel, it would not do to wait for regulation to improve transparency and openness
The illiquidity crisis came to light when the flagship fund of ‘star' fund manager, Neil Woodford, was suspended on 3 June, preventing investors from withdrawing their money. After a period of underperformance, the fund was unable to meet withdrawal demands and it is expected to remain closed until Christmas. This situation has understandably caused considerable frustration for the investors affected, leading to calls for closer control and regulation.
The regulator's response has caused some controversy, however. While the Financial Conduct Authority's (FCA) recent focus on disclosure has been welcomed by many across the industry, its assertion that investors should have known that Woodford's Equity Income Fund could be suspended has attracted criticism.
The regulator's chief executive, Andrew Bailey, recently told the Treasury Select Committee (TSC): "Suspension is a tool that is very clearly set out in the prospectus". Taking issue with the FCA, the Association of Investment Companies (AIC) subsequently wrote to the parliamentary committee to explain that such mentions are not enough, and many investors may not have read the fund's full prospectus anyway.
It is worth noting that elsewhere in Woodford's prospectus it is clearly stated that "shares in each fund may be redeemed on any dealing day". It is easy to understand how this could give a misleading impression to investors who may not realise that trading could be suspended.
Whether regulation is needed to tackle this potential area of miscommunication is less certain and industry self-regulation is likely to be the preferred approach. In view of recent events, the industry is likely to agree that greater clarity in the way open-ended funds are promoted to investors is required and fund managers taking this action proactively could help to restore confidence and stem current outflows.
At the end of the day, investors may not be happy to learn that redemption gates are an option, but they would be far less happy to discover this after the event.
Another potential area of regulatory focus is the issue of illiquidity. The FCA has recently consulted on new rules, which followed a series of high-profile property fund suspensions in 2016. The rules are expected to require funds investing in property and other illiquid assets to tighten up their management in this area and the regulator has promised to take the Woodford fund crisis into account before implementing any changes.
The AIC recently called for new rules for open-ended funds that hold illiquid assets. Specifically, the organisation thinks open-ended fund providers should be forced to justify their decision to place illiquid assets, such as unquoted companies and property, in this type of structure and explain why it is "in the best interest of consumers". In doing so, they would need to consider the nature of underlying assets, redemption policy and cash holdings. If necessary, higher cash buffers could be used to protect the fund.
Mark Carney's recent comments that open-ended equity income funds are "built on a lie" have further dented perceptions of these investment structures and tighter regulatory controls at some stage are probably inevitable.
Regardless of what the regulator chooses to do next, the fund management industry as a whole cannot afford to sit back and wait for changes. It is important to take steps now to improve clarity and ensure investors have a sound understanding of the risk profile of their investments.
Kavita Patel is head of investment funds at law firm Shakespeare Martineau
Square Mile's series of informal interviews
Follows active fee cuts in June
New shares admitted to London Stock Exchange
Elevated redemptions expected