Morningstar - Fall 2019 - 23

25% of the average volume of all the stocks in the
portfolio over their lifetimes, and another using
25% of the latest 30 days' volume. These
measures provide additional context and allow our
analysts to see if the current portfolio is likely to
have liquidity issues now.

In the case of LF Woodford Equity Income, it is
important to note that we are not modeling
actual liquidations. We recognize that Woodford
could deploy any number of strategies to
get the cash for redemptions. What the modeling
shows is how greatly the manager might
have to deviate from an established strategy to
do so. For example, if a manager is forced
to sell only a fund's most liquid holdings to meet
redemptions, it could dramatically change the
makeup and risk level of the portfolio.
When a manager is forced to sell down the most
liquid issues, it shows up in several ways.
One of the most noticeable is a shrinking average
Percentage
Portfolio
market cap.
It can beofdifficult
forRemaining
an outsider
100%
to determine if sales owe to liquidity pressures
or a change in style or conviction in names.
At LF Woodford Equity Income the average market
75 2014
cap has fallen sharply overall since its mid69
launch, even when the fund was experiencing
consistent inflows.
50
The sea change in the portfolio started in
24
the second quarter of 2017, when
25
Woodford decided to act on his bullish
view
18
261 trading days is one calendar year.
on the U.K. economy and began to move 0
43 away from
65 large-cap130
261
multinationals
to smaller domestic names (housebuilders,
retail, leisure), in addition to more idiosyncratic
early-stage stocks. This was before any
significant redemptions started. The fund
received its first sizable redemption in
May 2017, and the floodgates really opened in
August 2017. Since then, the fund has
consistently experienced more than GBP 100
million monthly net outflows.
In other words, an intentional shift into smaller,
less-liquid, names was unfortunately timed,
as it meant that the fund was less able to cope
with the significant redemptions that were
just around the corner.

LF Woodford Equity Income's Burndown Rate
Worst 30-Day Liquidity
Latest 30-Day Liquidity

Average 30-Day Liquidity

Percentage of Portfolio Remaining
100%

69

75

50
24
25
18

261 trading days is one calendar year.

0
1
Days to Liquidate

5

10

22

43

65

130

0
261

Source: Morningstar.

LF Woodford Equity Income's Market Cap Declines
Average Market Cap

Total Assets
$12B

9

6
3.7
1.1

3
0

07/2014

07/2015

07/2016

07/2017

07/2018

Source: Morningstar. Data as of 05/31/2019.

In fact, as of the end of April (our most recent
portfolio data), LF Woodford Equity Income owned
more than 19% of 23 different companies
and more than 15% of 13 more. Owning such large
proportions of individual firms can make it very
difficult to exit. Further, London Stock Exchange
rules dictate that investors who acquire,
exceed, or fall below 3% of a U.K. company (and
each 1% threshold above 3% up to 100%)
must disclose their interests to the exchange and
the company within two days. That puts the
investor at risk of being front-run by other market

participants. In the case of this portfolio,
hedge funds have already shown a willingness
to target the strategy with shorts.
Tom Whitelaw is director, equity ratings, with Morningstar
Research Services.
Peter Brunt is associate director, equity strategies, with
Morningstar UK.

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