Will Neil Woodford’s woes challenge the iconography of the ‘star’ fund manager?

Beware star fund managers. That is the first lesson from the freezing of Neil Woodford’s flagship investment fund. The second is that liquidity matters in investment, and that some holdings – typically in smaller companies – cannot be turned into cash in a hurry. And the third is that all investors should spread their risks.

What has happened is simply that some months of poor performance have encouraged investors to take their money out of his fund, and Woodford has not been able to sell its holdings fast enough to let them have their cash. Result: the underlying investments are still there and may go up or down, but meanwhile you cannot put money into the fund and you can’t take it out.

Woodford is one of the big names in London investment. He worked for Invesco for many years, produced very good returns for investors, and then set up on his own. Money flooded in: at its peak the flagship LF Woodford Equity Income Fund held more than £10bn of assets; it now checks in at about £4bn.

His strategy was to put money into companies that were out of fashion, perhaps because they had gone through a bad patch, and into smaller firms some of which did not have quotations on the stock market. This can work very well, but in this instance too many of his investments have gone wrong at the same time, and investors have understandably lost faith in his judgement.

There is an inevitable question about Woodford: was he really brilliant, or was he, for most of his career, just lucky?

I think the best way of answering that is to point out that nearly all investment managers have good and bad patches, and we should be suspicious of suggestions that any manager is a true “genius”. People with long memories will remember the adulation that Jim Slater generated in the 1960s and early 1970s. Then it all went wrong. More recently Anthony Bolton, manager of Fidelity Special Situations Fund from 1979 to 2007 was ranked as the number one UK fund manager. But when he returned in 2010 to run a China fund things went downhill, and he duly retired.

Over in the US, Bill Gross had a long and massively successful career running bond funds at Pacific Investment Management Company. He built Pimco’s Total Return Fund into the largest bond fund in the world, but when he left to join Janus Capital in 2014 he seemed to have lost his touch.

Even Warren Buffett, “the Sage of Omaha”, who achieved legendary status, has faltered in recent years. The performance of his investment company Berkshire Hathaway has actually been rather poor – slightly worse over the past decade than the S&P 500 index. He had a wonderful run from the 1960s through to the early 2000s, so anyone who invested early will have done very well. But since the financial crash of 2009 investors would have done better to invest elsewhere.

That leads to lesson two: the importance of liquidity. If you are likely to need cash fast, then make sure that your investments can be cashed in quickly. That goes for Woodford, but it also goes for the rest of us. It will probably never have occurred to him that his fund might have to face a run of investors pulling out their cash on the scale that has happened. But as anyone who has had to sell a house quickly will know, a forced seller will get a worse price than one who can afford to wait a bit.

As for lesson three, the need to spread risks, the point is very simple. None of us can know which investments will do well in the future and which will languish. That is not the way the world works.

The “value” strategy Woodford uses is a sound one. It is broadly similar, though on a much smaller scale, to that of Warren Buffett. But over the past five years or so value investments have been beaten by high-technology ones. Besides, buying shares that look cheap is a great idea, except they are usually cheap for a reason. There is something wrong with the company, or the market in which it is trading.

The really worrying thing about this whole episode is not that the investors who are locked into their Woodford fund will have lost money. If the markets recover in the coming weeks it is quite possible that they will end up better off as a result of being locked in. If markets go down, then that is a risk of all investment.

The real damage will be to the reputation of fund management in general. We have to save for our pensions. That money has to be invested. Fund managers have to make those investments. If we save less as a result of the dethroning of this particular investment king, then we are making a grave mistake. If we want a financially secure future, we should rely on compound interest, not a supposed star manager.

Some people will worry that this is a canary in the coalmine. The decade-long bull run that has defined equity markets since the financial crisis will have to end at some point, and only hindsight will tell us where the facade of confidence started to crumble. But if previous crises have taught us anything, it’s that investors really get nervous when someone tells them they can’t have their money.