Woodford, 2019Needs one idea

A daily-dealing fund holding things that took months to sell. The gate was not the failure; it was the moment the mismatch became visible.

3 min read · 533 words

What happened

• The structure — an open-ended fund offering dealing every business day, holding listed shares alongside a growing proportion of small, thinly traded and unquoted holdings.
• 2018 into 2019 — performance lagged and money left. Meeting redemptions meant selling, and the easiest holdings sell first, so the remaining portfolio became progressively less liquid.
• Some repositioning — steps were taken to change the mix of holdings, including listings of certain positions, which changed their formal classification.
• June 2019 — dealing in the fund was suspended, and investors could no longer withdraw.
• October 2019 — the decision was taken to wind the fund up rather than reopen it, and holdings were sold over an extended period, with proceeds returned in instalments.

The mechanism

• Daily dealing is a promise about time. It says nothing about what the fund holds. The mismatch is between the two, and it is invisible while inflows exceed outflows.
• Selling the liquid part concentrates the problem. Every redemption met by selling what is easy leaves the remaining holders with a fund that is proportionally harder to sell. That is the first-mover advantage that turns ordinary outflows into a run. It is the same arithmetic as can a fund stop me taking my money out.
• A limit expressed as a percentage moves when the denominator moves. Rules capping unquoted holdings as a share of the fund can be breached without a single purchase, simply because the fund shrank.
• Classification is not liquidity. A holding that is listed somewhere is not necessarily sellable in size. The label and the market depth are different facts.
• Suspension protects the remaining holders. It is the tool that stops the sequence, and it is written into the rules for that purpose — which does not make it painless for somebody who wanted their money.

What it teaches

• Match the wrapper to the holdings. Illiquid assets are not disqualified from being owned; they are badly matched to a daily promise. A closed-end fund or an interval structure holds the same things without the same failure mode.
• Read what the fund may hold, not what it currently holds. The limits in the prospectus describe the fund it is allowed to become.
• Outflows are a mechanism, not a verdict. The portfolio did not become worse because people left; it became less liquid, which is a different and more mechanical problem.
• Ask what happens to the last holder. In any structure where leaving is easier for the early than the late, that asymmetry is the risk, and it can be read off the documents before it is tested.

The mechanisms behind this

• Open-ended funds — subscribing and redeeming with the fund itself.
• Liquidity — the mismatch, in general terms.
• Closed-end funds — the structure that holds illiquid things without a door to run for.
• Can a fund stop me? — gates, suspensions and swing pricing.