Never forgetting about liquidity, accepting that bad runs are inevitable and coping with the “psychological strain” of going against the herd instinct are some of the lessons that all investors can learn from the ongoing problems facing veteran Neil Woodford, according to Fidelity Personal Investing’s Tom Stevenson.

It was announced yesterday that dealing in Woodford’s flagship equity income fund will be suspended in order to protect investors following a period of heavy redemptions and to give the manager time to sell some of his less liquid holdings.

The significant underperformance of the manager’s LF Woodford Equity Income fund has dominated the financial press for some time after a series of stock blow-ups led to the strategy being one of the best performing members of the space to one of the worst.

FE Analytics shows that the fund has made a total return of just 0.36 per cent since its launch a little under five years ago, which is the second lowest in its sector. Over the same period, its average IA UK All Companies peer has made 29.95 per cent while the FTSE All Share is up 30.07 per cent.

Woodford’s critics have pointed to the portfolio’s bias toward stocks linked to the UK domestic economy as well as its significant allocation to unquoted stocks as some of the factors prompting concerns.

Performance of fund vs sector and index since launch

Source: FE Analytics

This run of lacklustre returns has led investors to sell the fund, causing its assets under management to fall from more than £10bn at its peak in the summer of 2017 to around £3.7bn today.

The Financial Conduct Authority (FCA) is reportedly keeping an eye on the situation as part of standard procedure when funds are seeing large outflows and yesterday the decision was made to block investors from buying, selling or transferring units in LF Woodford Equity Income.

A statement from Woodford Investment Management said: "Following an increased level of redemptions, this period of suspension is intended to protect the investors in the fund by allowing Woodford, as previously communicated to investors, time to reposition the element of the fund’s portfolio invested in unquoted and less liquid stocks, in to more liquid investments."

Stevenson – an investment director with Fidelity Personal Investing – said that investors can take six valuable lessons from Woodford’s challenges. Stevenson made these comments before the fund was suspended, but they still provide investors with some useful insights.

Don’t ignore liquidity

“Woodford’s willingness to invest in more obscure, less-liquid and sometimes unquoted holdings would not be a problem if the fund had met investors’ expectations and flows in and out of the fund had been within manageable bounds,” Stevenson added.

Given that part of the reason for LF Woodford Equity Income’s suspension is to reduce the portfoio’s exposure to illiquid stocks, this point is arguably the most important and highlights the consequences that ignoring it can have.

LF Woodford Equity Income’s assets under management over 3yrs

Source: FE Analytics

The heavy outflows that followed LF Woodford Equity Income’s poor performance created big problems for the manager, as he has to work hard to keep to the regulatory limit of no more than 10 per cent invested in unlisted stocks.

“A basic rule of investment is never to become a forced seller,” Stevenson said. “That’s why financial planners always advise you to keep a few months’ income in an easy-to-access cash account.”

Ryan Hughes, head of active portfolios at AJ Bell, also pointed to the importance of liquidity when commenting on the suspension.

“The news that the Woodford Equity Income fund has suspended dealing will come as a shock to many people but it shows the sheer scale of redemptions the fund has been suffering in recent months with the fund falling to under £4bn from a high of over £10bn two years ago. With an element of the fund in illiquid investments, it is clear that the fund was having to sell the more liquid holdings to fund the redemptions, which in turn can exacerbate the problem. This is not a decision that will have been taken lightly and it is done to protect the interests of remaining investors,” Hughes said.

“Woodford has indicated that they will be looking to reposition the portfolio away from illiquid holdings during the suspension and therefore investors may have to be patient for the fund to reopen. Events such as this are rare but it is a reminder to all of the risks that come with investing in illiquid assets while offering daily liquidity to investors. This never appears to be a problem when money is flooding in but when sentiment turns it can come back to bite investors badly as has happened here.”

Contrarian investing is difficult

Woodford’s contrarian approach revolves around finding stocks that are unloved by other investors but going against the tide can led to periods on underperformance and “enormous psychological strain”.

“To hold your nerve and stick to your investment beliefs when the market is saying you’ve got it wrong requires great strength of character,” Stevenson said.

He added that Woodford “clearly believes” weak sentiment towards the UK market has gone too far, particularly in out-of-favour areas like housebuilders and some consumer stocks where he is overweight, and expects this to turn around.

“But the wait for the rest of the market to catch up with his thinking is agonising,” the Fidelity investor director said. “And it may never happen, of course. The biggest challenge for a true contrarian investor is dealing with the fact that you might actually be wrong.”

Keep it simple

There is an argument that some of the criticism of Woodford stems from a mismatch between investors’ expectations of what his funds should do and how he is actually running the portfolios.

“Most people buy an equity income fund in the expectation that it will invest in large, secure, dividend-paying shares,” Stevenson said. “A glance at the holdings of the Woodford Equity Income fund shows how different it is from its peers.”

Traditional hunting grounds for equity income managers include the oil & gas, pharmaceutical, mining and banking sectors, but Woodford holds little here. Instead, his top holdings include the likes of Barratt Developments, Provident Financial and Theravance Biopharma.

All fund managers have a bad run

Stevenson also pointed out that there is not a single fund manager in the business who has not had to go through a barren patch. He noted that every great investment career includes periods when “nothing seemed to be going right.”

Performance of Woodford’s Invesco Income fund in year before tech crash

Source: FE Analytics

Indeed, Woodford himself has experienced this in other high-profile occasions. In the dotcom boom, he was criticised for avoiding technology stocks but this allowed him to dodge the crash; likewise, his decisions to not hold banks was justified when the financial crisis took place.

“No-one knows when things will look up for Woodford, but no-one creates his long track record by luck alone,” Stevenson said. “There’s a talented manager there who has made a number of bad calls. Probably the worst thing he could do would be to change tack now.”

Diversification matters

One lesson that all investors can take note of is the importance of spreading risk across a variety of different geographies, asset classes, styles and managers is essential.

Investors whose entire portfolios are built around Woodford are undoubtably feeling the pain while those who include LF Woodford Equity Income as part of broad mix of funds are likely to be more sanguine.

“No-one has a crystal ball and the past is a poor guide to the future in investment,” Stevenson explained. “A balanced portfolio will ensure that a problem in one area of our investments will not sink the whole ship. Living to tell the tale is half the battle.”

Choose the right vehicle

The final lesson for investors highlighted by the Fidelity investment director is the importance of using the right wrapper for your holdings.

He noted that open-ended funds are suited to highly-liquid investments like large shares traded on stock exchanges. However, they are not the best option for investments like property and unquoted shares as it is not always possible to quickly find a buyer for these illiquid assets at sensible prices.

The challenges faced keeping LF Woodford Equity Income within its unquoted limit and its recent suspension have highlighted the importance of using the right vehicle for unquoted stocks. In the case of property, this was brought home in 2016 by the suspension of open-ended property funds after the EU referendum sparked heavy redemptions.

“Ironically, Woodford understands liquidity well – it is why he set up the Patient Capital investment trust as a source of permanent capital to invest in potentially high-growth but fundamentally illiquid investments,” Stevenson concluded.