PDF Summary:Built on a Lie, by Owen Walker

The meteoric rise and calamitous fall of Neil Woodford, once Britain's most renowned investment manager, is laid bare in Built on a Lie by Owen Walker. Beginning with Woodford's early career and success at Invesco Perpetual, the book chronicles his audacious decision to establish his own fund management firm—and the subsequent growth and eventual unraveling of his multi-billion-pound Equity Income fund due to ill-fated investments in unquoted companies.

This saga grants a behind-the-scenes look at the UK investment industry, exposing conflicts of interest between advisers and everyday investors. It prompts vital questions on regulation, transparency, and ethical reform needed to restore public trust in a system that spectacularly failed those who entrusted Woodford with their life savings.

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The Rise of Celebrity Fund Managers and Influencers Like Woodford

Investing can be overwhelming for the average person. The sheer number of available funds and products, coupled with how complicated financial markets are, creates a strong need for reliable guidance. This is where financial advisors and wealth managers step in, offering their expertise to help investors navigate this intricate landscape. As author Owen Walker emphasizes, their role is crucial in helping investors understand and manage their financial future, especially in light of changing retirement plans that place increased responsibility on individuals to plan for retirement.

However, Walker highlights a concerning trend—the emergence of "celebrity fund managers." These individuals, often charismatic and with impressive past performance records, become the focus of marketing campaigns and media attention, drawing in significant capital based on their reputation. Woodford was a prime example of this phenomenon, his success at Invesco Perpetual fueling the narrative of a gifted stock selection expert who could consistently outperform the market. This star status created a powerful following, with investors like Fred Hiscock and Pauline Snelson putting their life savings in his hands based on his perceived ability.

Context

• Successful investing often requires continuous monitoring and analysis, which can be time-consuming and requires a level of expertise that the average person may not possess.
• The rise of fintech and algorithm-driven investment platforms has increased the complexity of choices available to investors, necessitating expert advice to leverage these tools effectively.
• Advisors help mitigate emotional decision-making, which can lead to poor investment choices. They provide a rational perspective during market volatility.
• They help demystify complex financial products and strategies, making it easier for investors to make informed decisions.
• Inflation can erode the purchasing power of savings over time. Individuals need to plan for investments that outpace inflation to maintain their standard of living in retirement.
• Investors may fall prey to cognitive biases, such as the halo effect, where the perceived success of a fund manager in one area leads to an overestimation of their abilities in all areas.
• Impressive past performance can be a double-edged sword. While it attracts investors, it can also create unrealistic expectations for future returns, as past success does not guarantee future results.
• Financial firms may use the image and success stories of these fund managers in advertising campaigns to attract new clients. This can include testimonials, case studies, and promotional events that highlight their past achievements.
• Celebrity fund managers often receive extensive media coverage, which can amplify their reputation and create a perception of infallibility. This media attention can lead to increased public trust and interest, regardless of the actual risk involved.
• The collapse of Woodford's fund prompted scrutiny from regulators and sparked discussions about the risks associated with the cult of personality in fund management and the need for better investor protection.
• Invesco Perpetual is a well-known investment management company based in the UK, recognized for managing a range of funds across different asset classes. It has a reputation for strong performance and a significant presence in the investment community.
• Woodford's past performance at Invesco Perpetual was characterized by high returns, which contributed to a perception of infallibility and led investors to overlook potential risks.
• Retail investors, like Hiscock and Snelson, often lack the resources and expertise to independently assess fund managers, making them more susceptible to marketing and reputational influence.

Conflicting Incentives: Financial Advisers, Fund Managers vs. Retail Investors' Interests

A worrying problem within financial advising, highlighted by Walker, is the conflict of interest between advisers, fund managers, and the investors they're meant to serve. Often, lucrative incentives, such as commissions and bonus structures tied to sales volume, push both financial advisors and those managing funds to prioritize pushing certain products over considering what's truly in their clients' best interests. This creates a dangerous dynamic, where short-term gains are prioritized over long-term financial security for those investing.

This tension is evident in the connection between Woodford and Hargreaves Lansdown and SJP. Both companies strongly endorsed Woodford's funds, motivated by the significant capital they attracted and the subsequent revenue they generated. This focus on immediate financial gain overshadowed genuine concerns about Woodford's investing approach, particularly his burgeoning commitment to non-public, non-liquid holdings. Walker suggests that this conflict of interest within the industry, where short-term profits were prioritized over investors' long-term interests, played a significant role in the Woodford affair.

Other Perspectives

• Some financial products that offer higher commissions to advisers may also provide substantial benefits to clients, and the selection of such products could be justified based on the clients' financial goals and risk tolerance.
• In certain economic environments, focusing on short-term gains could be a prudent strategy to avoid losses or capitalize on fleeting opportunities that could benefit the investor's portfolio in the long run.
• Companies like Woodford, Hargreaves Lansdown, and SJP may argue that their endorsements of funds are based on a variety of factors, including long-term performance metrics, risk assessments, and the alignment of the fund's strategy with the client's investment goals, rather than solely immediate financial gain.
• The presence of independent and third-party review processes can provide additional oversight, reducing the impact of conflicts of interest on investment decisions.

Advisers' Failure to Warn Investors About the Risks of Woodford's Financial Products

Walker criticizes investment advisers for not adequately warning investors of the risks associated with Woodford's funds. Despite growing concerns within Hargreaves Lansdown regarding Woodford's strategy, particularly his ballooning holdings in privately held companies, their research team, led by Mark Dampier, chose to remain silent. Dampier, a self-proclaimed "Woodford groupie," continued to champion Woodford until Equity Income suspended trading, prioritizing the lucrative relationship over fulfilling his advisory responsibility to inform clients about potential risks.

Walker also highlights Woodford IM's flawed due diligence procedures. Despite claiming to be fully transparent, the company’s investment team, led by analyst Saku Saha, failed to conduct thorough assessments of the unquoted companies they poured millions of pounds into. Walker uses the example of Woodford’s investment in Evofem, where none of the team had visited the company’s headquarters despite committing millions of dollars. This lack of scrutiny further compounded the risks associated with Woodford’s funds, ultimately harming the individual investors who trusted him with their savings.

Other Perspectives

• Advisers may have provided general risk disclosures that are standard in the industry, which could have been overlooked or misunderstood by investors.
• The research team might have had a long-term perspective on Woodford's funds, considering the volatility and risks as temporary challenges that would be overcome with time.
• The criticism assumes that Dampier had full discretion to communicate risks, but there may have been organizational or regulatory constraints that limited what he could say publicly about the funds.
• The success of due diligence also depends on the availability and transparency of information from the companies being invested in, which may have been limited in the case of privately held companies.
• The information available publicly and through networks might have been comprehensive enough to make a well-informed investment decision without additional scrutiny.
• In the context of a diversified investment portfolio, the team might have assessed that the level of risk associated with the Evofem investment was acceptable relative to the overall fund strategy.
• It is possible that the investment team had other sources of information or analysis that compensated for not visiting Evofem's headquarters, which could have been deemed sufficient at the time.

Uk Investment Industry Evolution and Deregulation Impact

This section explores the historical context surrounding the Woodford saga, focusing on the impact of deregulation in London's financial district during the 1980s—an event dubbed the Big Bang. It investigates how these reforms reshaped the landscape of British asset management, its increasing influence, and the creation of new investment products that imposed a greater burden on individual investors to manage their own savings responsibly.

1980s City of London Big Bang Deregulation and Its Impact on Investment Management

This sub-section examines the profound impact of the 1986 Big Bang deregulation on the City of London, specifically how it transformed the investment management field. The focus is on the shift towards a globalized and competitive financial industry, the rising influence of investment firms and fund managers, and the creation of investment products like Peps, which marked a crucial step in increasing individual accountability for managing savings.

Shift to a Competitive, Globalized Financial Services Industry

The 1980s witnessed a dramatic transformation of the financial landscape in the UK. The Big Bang deregulation, spearheaded by Margaret Thatcher's government, aimed to shake up London’s financial sector by ending set commission fees and eliminating the separation between stockbrokers and stockjobbers. This move significantly reduced trading costs and paved the way for global investment banks to establish a strong presence in London. As author Owen Walker explains, this attracted a different type of investor and transformed the City from a traditional, clubby environment to a more vibrant and competitive hub of worldwide financial activity.

This deregulation also coincided with the emergence of electronic trading, moving the industry from the frenzied open outcry system to a more data-driven, automated model. These shifts not only revolutionized London; they profoundly impacted investment management. The dismantling of entry barriers led to a surge in the number of investment funds and products available, while the introduction of Peps encouraged retail investors to take a more active role in managing their savings. Ultimately, Walker argues, the Big Bang deregulation laid the groundwork for a landscape controlled by major financial institutions and leading fund managers, paving the way for Woodford's rise.

Practical Tips

• Use the concept of market integration, inspired by the merging of stockbrokers and stockjobbers, to diversify your investment portfolio. Consider combining different types of investments, such as stocks, bonds, and real estate, to create a more resilient financial strategy, much like the integrated services offered post-deregulation.
• Engage with a financial advisor to discuss the potential benefits of international banking services for your personal finances. They can provide tailored advice on how to leverage global investment banks' presence in London to your advantage, such as better currency exchange rates or international investment products that were previously less accessible due to higher costs.
• Engage with a local business or startup incubator to volunteer and observe how new companies are shaping the competitive landscape. By assisting with events or workshops, you'll witness firsthand the impact of innovation and competition on a sector, mirroring the transformation experienced by London's financial district.
• Experiment with creating simple trading algorithms using spreadsheet software. Even if you're not a programmer, you can use Excel or Google Sheets to set up basic algorithms based on data like stock prices or moving averages. This exercise will help you grasp the logic behind automated trading and the importance of data in making trading decisions. For instance, you could create a spreadsheet that signals when to buy or sell a stock based on specific price thresholds you set.

Investment Firms and Portfolio Managers' Growing Influence

After the Big Bang, the UK investment sector witnessed a significant shift in power dynamics. Major institutional backers, including pension and insurance funds, amassed considerable assets, giving them a powerful voice in corporate Britain. The emergence of celebrity fund managers, like Woodford, further amplified this influence, with their investment decisions directly impacting the share prices and strategies of large companies. Author Owen Walker emphasizes this growing clout and how it blurred the lines between investment and corporate control, with fund managers like Woodford actively intervening in boardrooms and influencing mergers and acquisitions.

The increased reliance on financial managers to manage savings, spurred by government initiatives like Peps and later ISAs, created a fertile ground for the phenomenon surrounding individuals like Woodford. This dependence, as Walker points out, amplified the likelihood of conflicting interests. The self-interest of those who manage funds, often tied to inflated bonuses determined by fund size rather than performance, could clash with investors' desire for long-term gains and stability.

Other Perspectives

• While major institutional backers did gain significant power, it's important to consider the role of market forces and economic cycles that also influence power dynamics within the investment sector.
• The assertion that pension and insurance funds have a powerful voice in corporate Britain overlooks the role of international investors and global capital flows, which can be equally or more influential in shaping corporate strategies and share prices.
• The influence of fund managers on mergers and acquisitions might be overstated, as these decisions are ultimately made by the companies' boards and require approval from regulators and shareholders.
• Financial literacy programs and online investment platforms have empowered many individuals to take a more active role in managing their savings, potentially reducing the reliance on financial managers.
• Investment firms and portfolio managers, while influential, are still subject to regulations and oversight that are designed to prevent them from exerting undue control over corporations.
• Fund managers are often subject to fiduciary duties, legally binding them to act in the best interest of their clients, which can counteract the potential for self-interested behavior.

New Investment Products and Increased Responsibility on Investors to Manage Savings

The deregulation of the financial markets in 1986, coupled with Thatcher’s privatization drive, ushered in a new era of individual responsibility for finances and life after work. The introduction of Peps and later ISAs aimed to incentivize equity investing among the British public, shifting the responsibility from employers towards individuals in managing their long-term financial security. This created a boom in the financial sector, with retail investors seeking guidance from financial planners and portfolio managers to navigate the growing complexity of the market. As Walker argues, this dynamic contributed to a fundamental disconnect between investors and the management of their funds, paving the way for potential abuses of trust.

While these policy changes aimed to democratize investment, Walker suggests that they also paved the way for individuals to be taken advantage of by unscrupulous professionals within the increasingly lucrative investment industry. The proliferation of new investment products and the reliance on fund managers like Woodford, whose investment strategies were often opaque and strongly shaped by conflicting incentives, created a system ripe for exploitation. Walker argues this complexity ultimately led to the Woodford saga, where retail investors, overwhelmed by market forces, placed their trust in an investment manager who ultimately betrayed them.

Context

• These were tax-advantaged investment accounts introduced to encourage individuals to invest in stocks and shares. PEPs were introduced in 1987 and later replaced by ISAs in 1999, offering tax-free returns to incentivize personal investment.
• The privatization drive encouraged ordinary citizens to buy shares in newly privatized companies, promoting a culture of individual share ownership. This was part of a broader effort to create a "share-owning democracy."
• During this period, there was a shift from employer-managed pension schemes to personal pension plans, increasing the need for individuals to actively manage their retirement savings.
• The shift towards individual responsibility was part of broader neoliberal economic reforms during Margaret Thatcher's government, which emphasized free markets, deregulation, and reduced state intervention in the economy.
• Investment decisions often had complex tax implications, and professional advisors provided strategies to optimize tax efficiency and maximize returns.
• Professional fund managers often had access to more detailed and timely information than individual investors, creating an imbalance in decision-making power.
• By encouraging more people to invest, the idea is to stimulate economic growth as more capital becomes available for businesses to expand and innovate.
• Even with regulations in place, there can be gaps or loopholes that unscrupulous professionals exploit, taking advantage of areas where oversight is weak or enforcement is lax.
• There have been historical instances where deregulation and complex financial products have led to financial crises, highlighting the risks of inadequate investor protection and oversight.
• After leaving Invesco, Woodford founded his own firm, Woodford Investment Management, in 2014. His new venture attracted significant attention and investment due to his previous track record.
• Woodford's funds were structured to allow daily withdrawals, but he invested heavily in illiquid assets, such as unlisted companies, which could not be easily sold to meet redemption requests.
• The Financial Conduct Authority (FCA) was criticized for not intervening sooner, as concerns about the fund's liquidity had been raised prior to the suspension.

The Aftermath and Consequences of the Controversy Surrounding Woodford

This section explores the consequences of the downfall of Woodford Investment Management, focusing on its effect on consumer confidence in Britain's investment industry. It examines regulatory lapses that contributed to Woodford's risky strategies, the detrimental impact on investors' retirement savings trapped in his investments, and the implications for reforming the UK investment management sector.

Fallout of Woodford Collapse and Consumer Confidence Damage

The collapse of Woodford IM sent shockwaves through the UK financial sector, shaking investor confidence and prompting investigations into regulatory failings and the role of financial intermediaries like Hargreaves Lansdown. As author Owen Walker illustrates, the controversy revealed a complex and often opaque investment landscape, where ordinary savers, reliant on professionals for guidance, ultimately bore the brunt of the monetary losses, leading to widespread anger and disillusionment. This saga unveiled the deep-seated flaws within a system that allowed star fund managers, like Woodford, to operate with minimal scrutiny, ultimately betraying the trust placed in them by a vast number of investors.

Walker emphasizes that the damage inflicted by the saga extends far beyond those directly impacted by Woodford. The reputational harm suffered by financial advisers like Hargreaves Lansdown raised doubts about the entire advisory industry and its ability to serve retail investors' best interests. The public outcry over the events further revealed a fundamental misunderstanding among savers about the nature of daily liquidity funds, particularly those investing in unquoted, illiquid assets. Bank of England governor Mark Carney hit upon this point in a memorable statement, declaring that such funds were “founded on a deception.” This underscored the industry's inability to adequately communicate the inherent risks to ordinary investors, eventually eroding public trust in this area.

Regulatory Lapses Enabling Woodford’s Risky Strategies

Author Owen Walker scrutinizes the Financial Conduct Authority (FCA) for its passive role in the Woodford saga, highlighting several regulatory lapses that contributed to Woodford's risky strategies. He argues that the FCA’s failure to act on early warning signs, such as the departures of Woodford IM's founding partners, Nick Hamilton and Gray Smith, who raised concerns about internal practices, and the breach of unquoted holding limits, allowed Woodford to operate with minimal oversight. Additionally, the FCA's decision to impose Link as the company responsible for authorization, despite its troubled history of fund oversight, further compounded the problem.

Walker criticizes the FCA's reliance on firms such as Link for routine supervision of investment products, maintaining that this outsourced approach led to a lack of understanding about the true extent of risk within Woodford's portfolios. He points to Link's slow response to liquidity issues, its failure to identify and act on conflicts of interest over valuations, and its delayed communication to the regulator about Woodford's creative maneuvers—including the listings in Guernsey and the asset swap with Patient Capital—as key contributors to the saga. This ultimately resulted in the fund's suspension, trapping investors and inflicting substantial losses.

Practical Tips

• Develop a habit of conducting quarterly reviews of any organizations or clubs you're a part of, looking for signs of instability such as high turnover or policy breaches. This can help you decide whether to continue your involvement or to start looking for alternatives that align better with your values and stability preferences.
• Create a checklist of criteria for assessing financial service providers before engaging with them. This list should include factors such as transparency, regulatory compliance, customer service quality, and the diversity of their investment products. Use this checklist when considering new investment opportunities to ensure you're working with reputable organizations.
• Create a personal conflict of interest register to maintain transparency in your dealings. Whenever you're faced with a decision that could benefit you personally, write it down and assess whether it could conflict with your other commitments or values. For instance, if you're considering a side job that might compete with your primary employer's business, document it and evaluate the ethical implications before proceeding.
• Initiate a peer review process for financial strategies where you invite a trusted colleague or mentor to assess your planned financial maneuvers. This process should involve presenting your strategy and its potential risks and benefits, allowing for an external perspective on whether you're maintaining the necessary level of communication with regulators and stakeholders. This can help catch any oversight and ensure that your actions remain responsible and transparent.

Impact on Investors' Retirement Savings With Woodford's Investments

The suspension and eventual wind-down of Woodford's funds had a devastating impact on the vast number of investors who placed their savings with him. Ordinary savers, many depending on his investments for retirement income, were left with substantial losses and locked out of their savings for an indefinite period. Author Owen Walker highlights the stories of individuals like Fred Hiscock and Pauline Snelson, whose life plans were irrevocably disrupted by Woodford's reckless investments and subsequent fund collapse. Walker underscores the stark reality for these victims, who, misled by the narrative of a celebrated investor and inadequate warnings from financial consultants, saw their hopes for their financial future shattered.

Walker draws attention to the injustice of Woodford and Newman's lavish payouts from the business, contrasting their multi-million-pound rewards with the losses suffered by their investors. The saga, he argues, demonstrated a morally bankrupt system where asset managers were incentivized to prioritize personal profits over the well-being of their clients. Walker underscores the need for greater accountability within the industry, highlighting that Woodford's actions severely undermined the public's trust in professional investors.

Practical Tips

• Create a personal financial contingency plan that includes a list of assets you can liquidate quickly if needed. This might involve setting up a separate emergency fund in a high-yield savings account or keeping a portion of your investments in assets that can be easily converted to cash, such as money market funds or treasury bills.

Other Perspectives

• The responsibility for investment decisions also partly lies with the investors themselves, who should assess their risk tolerance and conduct due diligence before investing, rather than relying solely on the reputation of a fund manager.
• Some investors may have had other assets or savings that helped cushion the impact of the fund's collapse on their overall financial situation.
• It's possible that the payouts were not directly funded by the investors' capital but rather from the firm's profits or other financial reserves.
• The system itself may not be morally bankrupt, but rather it could be the actions of a few individuals that led to these unfortunate outcomes.
• The financial industry is regulated to protect clients, with rules and oversight intended to prevent the prioritization of personal profits over clients' well-being.
• Trust in professional investors may be more resilient than suggested, with investors understanding that not all fund managers engage in the same practices as Woodford.
• Increasing accountability could lead to excessive compliance costs, which might be passed on to investors, potentially reducing their returns.

The Woodford Saga's Implications for the UK Investment Management Sector and Need for Reform

The Woodford scandal exposed a profound need for reform within the United Kingdom's investment management sector. Author Owen Walker argues that the saga laid bare inherent flaws in the system, calling into question aspects of regulation, financial intermediaries' functions, and the transparency of investment products marketed to retail investors. He criticizes the industry's culture of relying on star managers of funds to attract investment, warning that this approach fosters a dangerous dependence on individuals and creates an environment where ethical conflicts and abuses of trust can flourish.

Walker emphasizes the necessity of creating a stronger set of regulations with enhanced oversight. He argues that the FCA must move away from its reliance on authorized corporate directors, advocating for a more active approach to monitoring portfolio managers and addressing competing interests. He also emphasizes the importance of greater transparency for investors, calling for clearer communication about the risks associated with different fund structures, especially those involving assets that can't easily be converted to cash. Walker concludes by suggesting that this episode provides a critical juncture for the field to confront and address its systemic issues, advocating for bold reform that prioritizes investor protection over short-term profits.

Practical Tips

• You can diversify your investment portfolio by including international funds and alternative assets. By doing so, you mitigate the risk of being overly exposed to the flaws of a single investment sector, such as the UK's. For example, consider adding a mix of real estate investment trusts (REITs), commodities, or even art and collectibles, which often don't correlate directly with stock market performance.
• Engage in role-playing exercises with friends or family to better understand the functions of financial intermediaries. Take turns playing the role of a client and a financial intermediary, such as a bank or investment advisor. The 'client' can present a financial goal or problem, and the 'intermediary' must explain how they can assist, what products they would recommend, and how they earn their fees. This exercise can demystify the services provided by financial intermediaries and help you ask the right questions in real-life situations.
• You can become a more informed consumer by researching the regulatory frameworks of the products or services you use. Start by visiting government websites that detail regulations in sectors like finance, health, or technology. Understanding these can help you make better choices and advocate for stronger regulations when you notice gaps or issues.
• You can enhance your understanding of financial oversight by researching alternative governance structures used in other countries. Look into how different financial systems operate without relying heavily on authorized corporate directors, such as the use of independent boards or regulatory committees. This will give you a broader perspective on financial governance and may inspire ideas on how to improve the system in your own context.
• Engage in role-playing exercises with a friend or family member to simulate the management of competing interests. Take turns acting as different stakeholders with varying objectives, such as a risk-averse investor versus one seeking aggressive growth. This practice can sharpen your negotiation and decision-making skills by exposing you to diverse perspectives and the need for compromise and strategic thinking in real-time scenarios.
• Use social media to crowdsource opinions on fund transparency. Post questions on investment forums or social media groups asking for experiences with specific funds' transparency. This can provide you with a broader understanding of how different funds communicate risks and structures, helping you make more informed decisions.
• Create a feedback loop with customers or clients to uncover hidden systemic issues. Implement a simple, anonymous survey or suggestion box that allows customers to report issues they encounter. This feedback can reveal patterns that point to systemic problems, which you might not see from the inside.
• Advocate for investor protection by joining or forming an investment club that focuses on long-term value and ethical investing. Within the club, you can collectively research and discuss investment opportunities that prioritize investor protection, share best practices, and even engage with companies to encourage better policies. This not only amplifies your individual impact but also promotes a culture of responsible investing among peers.