UK star fund manager Neil Woodford apologized on YouTube to investors earlier this month after he was forced to suspend redemptions from his flagship fund in the wake of massive withdrawals. The way I see it, the key factor behind the fund’s major setback is poor cash flow management.
Legendary fund manager Peter Lynch delivered a staggering annual return of 29.2 percent during his 13 years as fund manger of the Magellan Fund at Fidelity between 1977 and 1990.
The size of the fund zoomed to US$14 billion in 1990 from US$18 million in the beginning.
The fund attracted a great number of new investors over the years, which meant huge cash inflows. US$14 billion was an enormous amount of money back in 1990. It was said that one in four American investors had put their money in Lynch’s fund.
When money keeps flowing in, a usual practice is for the fund manager to buy more of stocks he or she is familiar with.
When the core holdings of a fund keeps getting fresh buying interest, that would boost the stock prices, subsequently lifting the fund performances. This, in turn, would lure more investors to the fund.
Fund managers help others to manage their money, and cash flow is the lifeline. Track record is important, but that’s not enough.
Invesco, where Woodford once worked, is a long-established fund house with a mature operating system. Its fund managers only have to focus on the investing side. If there is any market turbulence, Invesco’s strong sales force will take care of it and keep redemption pressure to a minimum.
Woodford started his own fund in 2013, and his fund may not have been able to attract inflows constantly. When performance fell behind in a year or two, clients started to pull money out.
To meet redemption, Woodford would be forced to sell holdings. Rush sell usually means poor prices. And when the price of the fund drops, more customers would go for the exit.
If there is a cash flow crunch, all businesses would fail no matter how perfect the business model or products are.
Corporates cannot survive without cash flow, and it’s the same case for an economy.
This article appeared in the Hong Kong Economic Journal on June 14
Translation by Julie Zhu
[Chinese version 中文版]
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