How Woodford exploited the fundamental flaw in fund shortlists

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This article on Neil Woodford originally featured as a guest post on Gentleman’s Family Finances.

The story of active management and Neil Woodford

Every active manager has a story to tell about how they will outperform the market. Neil Woodford is no different. He believed that he could continue his winning streak by investing in companies that were overlooked and undervalued.

To help spread the story, Woodford teamed up with Hargreaves Lansdown, arguably the most influential storyteller in the UK. In exchange for selling his story to millions of investors, Woodford gave Hargreaves customers a discount to invest in his fund. In return, Hargreaves included his fund in their ‘Wealth 50’ list and encouraged investors to buy.

Fund shortlists

The Wealth 50 list is a shortlist of their experts favourite funds, a type of best buy list. They’ll tell you that it “isn’t personal advice”, simply a way to narrow the list of more than 3,000 available funds.

But speak to any Hargreaves customer and they’ll paint a very different picture. They’ll say things like, “I invested mainly because Hargreaves Lansdown was promoting it so much and hailing Woodford as a star investor”.

And that’s the problem. Hargreaves may not have been providing advice, but its customers didn’t see it that way. They felt that Hargreaves was making a “recommendation”, which they trusted and invested accordingly.

The fundamental flaw

Although best buy lists may have good intentions, there’s a fundamental flaw – what’s good for the platform/manager isn’t always good for the investor.

By including Woodford in the Wealth 50 list, Hargreaves secured a sizable discount for its customers. Naturally, having access to lower-cost funds meant that more money flowed in.

But when Woodford soured, he was kept in the Wealth 50 list.  They continued to promote the fund, despite poor performance. If Hargreaves truly believed Woodford was worth keeping, why did their Multi-Manager portfolios sell down the fund, whilst continuing to promote it?

It’s obvious. They knew that Woodford was a bad investment, but there was a commercial incentive to keep him on the list. In fact, they had concerns about the fund’s liquidity as far back as 2017, but nothing was done about it. As a result, thousands of investors have lost their hard-earned savings.

As an industry, what we’ve done is attempted to get people interested in investing by creating shortcuts in the form of best buy lists. But let’s be frank, shortcuts are designed by experts and used by amateurs. The average investor was generally uninformed about the risks of the Woodford fund, and when things went downhill, they relied on the shortcut they knew, the best buy list.

When best buy lists are designed for profit, rather than for the customers benefit, the customer will inevitably get burnt.

What can be done to prevent the next Woodford scandal?

So what can we learn and what should we do?

For starters, there needs to be greater regulatory oversight of best buy lists. Regulation should focus on protecting the customer from potential conflicts of interest. With such influence, a small statement at the bottom of the page telling you that your money is at risk doesn’t quite cut it.

We should also be wary of placing too much faith in the skills of any star manager. The best thing an investor can do is place their money in a well-diversified, low-cost index-tracking fund. Failing that, they should never buy a fund named after someone (there’s just too much ego).

If there’s one benefit to this whole saga it may be that customers come to appreciate that past performance really is no indication of future performance.

All the best,

woodford, Frazer James Financial Advisers

James Mackay, Independent Financial Adviser in Bristol

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Financial Advisor Bristol and Pension Advisor Clifton

Frazer James Financial Advisers is an Independent Financial Advisor based in Clifton, Bristol.

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