A couple of warnings before we begin - (i) this article is for entertainment purpose only and no part of it should be considered an investment advice, (ii) we have no financial position in the mentioned companies.
The Liquidity Crisis Faced by “Oracle of Oxford”
In a recent blog post titled “A decision point arrives for Oxford Nanopore”, we wrote about the IPO announcement from the company. The core of the article was on Neil Woodford, a long-term financial backer of the business. Woodford, often described as a “legendary investor”, “Britain’s own Warren Buffet” and “Oracle of Oxford”, has been facing liquidity crisis in his mutual funds.
Woodford’s situation took a dramatic turn last week. He blocked redemptions from his flagship fund, and subsequently all of his large investors fled. His “assets under management” (AUM) collapsed to half within days. It is currently at a small fraction of the AUM at its peak in 2017. Zerohedge wrote -
The severity of this latest hit to the hedge fund industry can not be underscored enough. The FT quoted a veteran fund manager who has known Woodford for more than 20 years, who said that “this is one of the bigger events for the UK asset management industry of the last decade. A bonfire of reputation and a terrible moment for investor confidence.”
The readers may find more information in the following articles - Multi Billion Fund Blocks Redemptions On Verge Of Annihilation, Woodford Loses Last Remaining Large Investor Woodford’s Fund Freeze Sends Chill Through U.K. Biotechs Neil Woodford risks being kicked off listed namesake investment trust
Rather than being an isolated event, this may become the beginning of the next financial crisis, as argues Bill Blain -
It’s a tad cruel, but a few months ago I was at a meeting at the University Investment Management advisory group, and we were reviewing post-grad research proposals. One of them was a semi-serious proposal to analyse Neil Woodford’s performance a fund manager; the aim would be to rate Woodford buy investments as reliable sell signals. Oh… how we giggled…
Woodford’s tumble from grace may prove to be a systemic moment for the fund management industry. Other funds, set up to mimic Woodford, have also gated themselves. I would not like to be Hargreaves Lansdown or St James when customers start to question fee arrangements and their roles directing them into Woodford funds. The Investment Association is concerned about the reputational damage Woodford’s done to the retail investment sector. (No Sh*t Award on its way…) The FCA wants to know if Woodford broke rules capping investments in unlisted assets… Maybe not, but he clearly arbed them.
We see merits in Blain’s argument. For our readers’ convenience, let us explain the reasons in simple language without investment jargons.
A Simple Recipe to Become a Billionaire
A 20-year old “bitcoin tycoon” recently announced - ‘If you’re not a billionaire’ in 10 years ‘it’s your own fault’. We fully agree but with a small change. The timeline should be shortened to 10 minutes from 10 years.
Here is the recipe. Place all your dirty underwears in a beautiful box, lock it and start telling everyone that the box has precious items worth $1B. Voila, you are a billionaire. You may even get some investors by using the box as a collateral. That way you can fly private jets like billionaires are supposed to do.
Even though the above recipe sounds rather silly, it is in fact at the heart of many supposedly serious investment strategies in the late phase of any business cycle. To get a feel for the last cycle, listen to this satirical video. “High-grade Structures Credit Enhanced Leverage Fund” was the shiny box to hide low-quality subprime mortgages. Here was another shiny billion dollar box in the cycle before. The nature of the boxes change from cycle to cycle, but the basic theme remains the same.
You may wonder why nobody opens the box to look inside. They do, but not during the rising phase of the business cycle. During the rising phase, the boxes are marketed by a large number of “experts”. Those shills may be Nobel laureates, scientists from reputed labs, rating agencies or Steve Jobs/Warren Buffett mini-mes. They spin yarns about an amazing future and challenge everyone expressing doubts about their fairy tales. Needless to say, those “experts” tend to receive financial compensations for their promotional works.
A liquidity crisis arrives, when investors finally figure out that their billion-dollar boxes were worth far less than billion dollars. This tends to happen during the declining phase of the business cycle, as described by Warren Buffett - “only when the tide goes out do you discover who’s been swimming naked”.
But Aren’t We at the Full Tide?
Here is the surprising aspect of Woodford’s case. The current economic conditions around the world are far from “tide gone out”. The stock markets of various countries are close to their respective peaks. Then why is he facing liquidity crisis?
In the last twenty years, similiar situations appeared only twice. Between February-July 2000, many dot-com companies went out of business even though general stock market, as measured by S&P 500, hovered around its peak. Webvan was the classic case in that era. Similarly, between January-August 2007, many mortgage companies in USA closed door. In both cases, the failures were described as isolated cases, but they turned out to be far more significant.
Of course it is possible that Woodford’s situation is an isolated case, but here we argue why not. Woodford was trying to do something intelligent with his funds. You can understand by parsing the investment models for the contemporary pension funds.
Typically pension funds invest directly in publicly traded companies, but for startups and other unlizted entities, they hand over their money to VCs, private equities and other “alternative strategy” funds. The publicly traded components get valued every day or every second, but the alternative investments get valued once in several months. There is also room for fudging the numbers, because the pension funds like to hear good numbers and alternative investment funds get paid more for reporting good numbers. As a result, two valuation systems exists for those two types of investments. The existence of hundreds of billion dollar unlisted unicorn is a direct result of overvaluation of unlisted companies.
Woodford decided to cut the VCs as middlemen and instead chose to make both types of investments himself. Therefore the failure of his fund appears ominous for the entire investment model. It is just that the market is forcing him to open his “unicorn boxes” before the other ones. We anticipate illiquidity to be a common theme in the coming months, as the valuations of the unicorns get challenged.