As a reminder, Woodford manages approximately one third of the assets in the UK Equity Income sector and his funds account for more than 5 per cent of the shares in companies such as AstraZeneca, BT and Imperial Tobacco. Naturally, there has been a lot of news coverage since the announcement, which has no doubt helped investors in the Invesco Perpetual Income and High Income funds to form their own opinion on whether to redeem or maintain their investments.
According to a recent FE Trustnet poll, 29 per cent of FE Trustnet readers said they planned to sell out of Woodford's funds in light of the news.
Using this worst-case scenario, we will now look at what the consequences of such redemptions for the funds and the UK Equity Income sector could be. Currently, Invesco Perpetual has confirmed that only 4 per cent of the two funds’ assets have been redeemed, therefore this is purely theoretical.
First, let’s focus on investors in the Invesco Perpetual Income and High Income funds – in particular, investors who are planning to redeem. Would Invesco Perpetual be able to return money to unit holders in time? In other words, are the two funds liquid enough to face these redemptions?
At the end of June 2013 we performed a quick liquidity study based on the latest available data for the Invesco Perpetual High Income portfolio. Assuming a 30 per cent redemption from the High Income fund and assuming that each day the manager is able to trade 30 per cent of the one-day average trade volume for a stock, it would take 13 days for Invesco to deal with these redemptions.
If we then consider the most extreme scenario where the manager must meet a 50 per cent redemption level, and only achieves 10 per cent tradable volume, it would take a full 71 trading days, or more than 14 weeks, for Invesco to fulfill client withdrawals. The results based on the different scenarios are displayed below.
Days it would take to liquidate Invesco Perpetual High Income
| Days to liquidate | 10% tradable on one day | 20% tradable on one day | 30% tradable on one day |
|---|---|---|---|
| 10% redemption | 11 | 6 | 4 |
| 20% redemption | 22 | 11 | 8 |
| 30% redemption | 37 | 19 | 13 |
| 40% redemption | 52 | 26 | 18 |
| 50% redemption | 71 | 36 | 24 |
Source: Bloomberg
While the extreme scenarios are quite concerning, overall these projections are actually reassuring and indicate that Invesco Perpetual could deal with the expected level of redemptions.
However, Mark Barnett’s willingness to raise the cash level for the funds if needed is a welcome one: it places the funds in a better position should such a situation arise and means he will not be forced to sell positions. This means the fund’s performance will not be impacted.
Using our calculation based on the portfolio at the end of June, 4 per cent of the portfolio is invested in unquoted stocks but a large part of the portfolio is in stocks with very low trading volumes. It also appears that 39 positions cannot be exited entirely in less than 90 days. These 39 positions represent 24.79 per cent of the portfolio.
Days it would take to entirely liquidate IP High Income’s holdings
| Days to liquidate | Number of entire positions exited | % of Portfolio | % of entire positions exited |
|---|---|---|---|
| 1-10 days | 8 | 4.67% | 4.67% |
| 11-30 days | 6 | 15.53% | 20.20% |
| 31-60 days | 11 | 29.04% | 49.24% |
| 61-90 days | 8 | 26.03% | 75.27% |
| 91 - 180 days | 9 | 9.92% | 85.19% |
| 181 - 360 days | 12 | 9.12% | 94.31% |
| > 360 days | 18 | 5.69% | 100.00% |
Source: Bloomberg
Now let us consider the consequences for the UK Equity Income sector, of which the Invesco Perpetual Income and High Income funds are the two largest funds, with £10.4bn and £13.8bn of assets under management.
One of the UK Equity Income sector’s main features is its concentration: the largest funds are typically invested in the same companies, such as GlaxoSmithKline, BP, AstraZeneca, Royal Dutch Shell, BAT, BT Group, Imperial Tobacco Group, Vodafone, BAE Systems, and HSBC Holdings.
At least five of these companies appear in the top-10 holdings of the 14 funds with more than £1bn assets under management. On average, these 10 stocks are present in two-thirds of UK Equity Income funds.
On average, every stock represents 4.1 per cent of a fund’s assets in that sector. We can conclude that unit holders of the Invesco Perpetual Income or High Income funds can reinvest their cash in other UK Equity Income funds whose investment style and approach to selecting stocks is similar to Woodford’s. These managers look at the same metrics when analysing a company: free cash-flow, dividend growth and strategic positioning.
Therefore, even in the case of large redemptions, Mark Barnett should find it relatively easy to find buyers among his peers for shares he needs to sell.
Since the redemptions are likely to be switched into competing UK Equity Income funds, it is fair to say that these competitors will then have to top-up existing holdings with this new cash.
This means the money may simply just be changing hands within the sector and so liquidity is less of a concern.
It is getting harder for UK income managers to differentiate themselves, as the investable universe is getting smaller. Thanks to the recent equity rally, valuations on the UK equity markets are less compelling and dividend yields have become compressed. Income managers have been forced to invest in the same companies, resulting in a limited capacity to differentiate from their sector peers.
Thus, the concentration in this sector does make Woodford’s departure more than just a problem for Invesco. If investors decided to move out of UK Equity Income en masse, then any downward pressure on stock prices would be felt by the majority of funds in the sector.
Charles Younes is a fund analyst at FE Research. The views expressed here are his own.
To read more of Younes' views on valuations in the UK Equity Income sector, click here.
