“News of Woodford’s fund suspension has dominated lately and while investors in his fund can only wait out the suspension for now, there are some important lessons that can be learnt for future,” says Laura Suter, personal finance analyst at investment platform AJ Bell. “Whether it’s assessing your current portfolio or using this checklist next time you’re planning to invest in a new fund, the Woodford situation highlights some areas investors need to check before buying.”
The 10 lessons to learn from the Woodford fund suspension:
1) Liquidity – “You need to understand the liquidity profile of the fund you are considering and accept that if you want exposure to illiquid assets, you may not be able to get your money when you want it. Liquidity is being able to sell the size you want, at the price you want, when you want – and as investors have found, investing in unquoted smaller companies via an open ended fund can create a liquidity mismatch. Just because a fund says is offers daily dealing, doesn’t mean it always will.”
2) Capacity – “Be wary of funds that get too big. A very large fund that invests in smaller companies might not be appropriate if it takes very large stakes in the underlying businesses. While it is always tempting to follow other investors into big funds, be careful and try to understand whether this size may actually be detrimental to long-term performance or liquidity.”
3) Investment drift – “Most managers are good at sticking to a well-defined investment approach that sees them invest in a particular type of company. Sometimes, managers drift away from what they’re good at and start investing in companies away from their core competence. This can be a fund manager moving from investing in large companies into smaller ones, or it can be a manager changing their style of investing. This ultimately changes the fund into something different to what most investors originally thought they were buying.”
4) Investor concentration – “It’s important to be wary when a few investors control a large proportion of fund assets. If they decide to sell it can cause serious problems for the fund manager, particularly if they are investing in illiquid assets. Therefore, it is always worth asking what proportion of the fund the top five investors own.”
5) Following a ‘star’ – “No one fund manager has the secret recipe to outperforming the market in all conditions and therefore you should expect everyone at some point to have bad performance when their style is out of favour. If someone has a good long-term track record, don’t just assume it will continue.”
6) Understand investment style – “It’s vital to understand how a manager invests before you give them any money, as it can be very painful to learn with your own money. Careful due diligence is rarely wasted. Understanding in what market conditions a fund should do well or badly should give you a good frame of reference for determining whether the performance is in line with your expectations or not.”
7) Look beyond the name – “Just because two funds say they invests in UK equities doesn’t mean they have the same risk or indeed can be compared. Both may sit in the same sector but you could be comparing apples with pears, for example a fund investing in large well-known UK companies can be very different to a fund investing in small and medium-sized UK companies. You must look beneath the bonnet, and beyond the fund name, to understand what is going on.”
8) Spread your eggs – “You don’t want to put all your eggs in one basket, so make sure that one fund manager isn’t running too much of your portfolio. You should check that you have a good spread across different funds or holdings, and re-balance your portfolio each year so you don’t end up too concentrated.”
9) Don’t follow the herd – “Don’t just invest in a fund because your friend has or someone told you they made a lot of money from the manager, do your own research. The same goes for following platforms’ Best Buy lists – use them as a guide or a starting point, but make sure you do your own research so you understand the fund, how it invests and why you’re buying it.”
10) Check cross holdings – “If a manager is running more than one fund, how many of the stocks are held across both funds? If a manager has to sell in one portfolio, it may cause the price to fall in the other. Therefore, look not just at the fund you are interested in, but other funds run by the same manager.”
