The impending departure of Invesco’s Neil Woodford has highlighted the need for buy-side traders to use transaction cost analysis (TCA) to help plan for the impact of major internal events, such as the departure of a star fund manager, according to financial data provider Markit.
Woodford, Invesco Perpetual’s most high-profile fund manager is stepping down in 2014 to set up his own boutique investment house and Markit said the potential risk of fund redemptions from investors that want to follow him is something the firm’s dealing desk should prepare for.
Markit used its TCA service to examine a trading scenario assuming investor redemptions rise enough that dealers would need to sell around 10% of his funds’ holdings, which it said was in line with the experience of other asset managers in similar circumstances. With Woodford responsible for around £30 billion in assets there is a significant market impact risk from selling his shares.
Among the large cap stocks in his portfolio, Markit’s analysis found they could move on average by about 0.38% as a result of a sell-off, rising to as much as 0.5% for British Telecom and Reckitt Benckiser.
“I think it’s vital for buy-side firms that are facing these kind of major events where there could be a lot of redemptions that they plan well in advance. Having a plan of action for how you’re going to deal with this could potentially help reduce market impact,” said Michael Richter, director at Markit.
Invesco Perpetual declined to comment, but is known to have a handover process in place. Woodford is not set to leave until April 2014 and is expected to be succeeded by Mark Barnett, who has been keen to promote a sense of continuity.
Richter said it was likely the Invesco trading team has been planning for Woodford’s departure for some time to minimise any market impact suffered as a result of significant share disposals, using TCA to examine the worst affected stocks so they can find the liquidity needed.
“There’s a tendency to think that TCA is predominantly for post-trade analysis, but this shows the advantage of using pre-trade TCA pro-actively to plan trading strategies. Our model gives you an indication of the market impact you would expect to have,” Richter explained.
Small stock troubles
However, Woodford’s portfolio also includes an unusually high number of smaller stocks, according to Markit, and this could be problematic when attempting to meet redemptions.
Problems in accessing liquidity are driving asset management groups away from smaller stocks in general, despite their potential for alpha.
“There have been precedents in the last ten years where fund management groups try to avoid having too many illiquid stocks in a portfolio,” said Will Duff Gordon, research director at Markit.
“There will always be very talented active managers and if they have that Midas touch then they will largely be able to invest however they like. But if we look at the way the buy-side is developing, it’s becoming more systematic, more programmatic and quantitative.”