Features | Editorial | 13 Mins Read | by AG Latto
The Sunday Times today has a long feature covering portfolio disclosure. A number of the largest open-end funds in the UK only list their top ten holdings. This means that no information is provided on over half of the investment portfolio. In my view, this is not ideal.
Why would fund investors want to know what is in a portfolio? It is the best way of seeing if a fund is doing what it says on the tin. 
Nothing else tells you more about a fund then the stocks it invest in. The two articles related to this issue in the Sunday Times are behind a paywall:
The Star Fund Manager hiding a £17bn Secret - 24 March 2019
Come on now Terry gives us the full story - 24 March 2019
Is it fair that a fund can operate without telling investors the companies it has invested in? I will leave that for readers to decide.
Best practice and the regulatory position
The Sunday Times article isn't clear on the legal requirements.
Recommended practice - The Investment Association (IA) "recommends" that funds disclosure a complete list of their investments at least twice a year.
The regulator - The Financial Conduct Authority according to the article: "says funds are required to publish a portfolio statement in line with these principles - meaning it too expects companies to disclose twice a year."
Putting the two together and The Sunday Times article appears to imply that full portfolio disclosure is required. I am not sure if this is the case. Full disclosure only appears to be best practice.
Update - 7th April 2019
It has been revealed to be the case that Fundsmith Equity Fund wasn't in breach of any rules. The Sunday Times has apologised to Fundsmith.
The two paragraphs that covered the issue in The Sunday Times were somewhat misleading in my view. They implied that the FCA requires full portfolio disclosure of open-end funds.
The reality is that the FCA doesn't require this.
The Sunday Times apology to Fundsmith/Terry Smith
Fundsmith statement on its website.
The explanations for non-disclosure from fund managers
There are many reasons that funds give for not disclosing their full portfolios. The two that are cited the most by fund managers are:
1) We don't want competitors to know our positions
The reality is that if a fund has over a 3% position in a UK company the position is disclosed to the market. The positions held by large funds are generally not difficult to determine.
Investment Trusts have to disclose all of their positions. I am not sure any Investment Trust has ever complained that this will lead to competitors knowing where they invest.
Many funds will give you their full positions if you ask them. This has been my experience with Fundsmith. The idea that competitors are not able to do the same is strange.
Many funds encourage investors to invest directly using their platforms. This makes investors more loyal to their funds. In my view, the fund manager should in return declare their full portfolio at least once a year.
It is not clear if competitors can really copy a fund if they only know its positions every six months. The full reports are also only made available a month or two after the reporting period.
If competition is a significant issue it could be addressed. For example, a fund could disclose its full holdings once a year and four months after the reporting period.
Fundsmith Equity Fund's recent purchase of McCormick was first revealed through US regulatory filings. The competition can, therefore, easily find out what large funds are buying and selling.
2) We don't want to be trapped in illiquid positions
The experience of Neil Woodford's funds has made some managers shy away from full disclosure. This risks learning the wrong lesson in my view.
Mr Woodford's runs open-end funds that invest in illiquid companies. This was never going to work out well when redemptions started to come in.
The lesson from Mr Woodford's troubles is that open-end funds should be wary of investing in illiquid stocks. The Fundsmith Equity Fund is an open-ended vehicle and invests in large blue-chip companies.
When Fundsmith launched an emerging market fund it was as a closed-end investment trust. The group launched a smaller companies fund that was also a closed-end investment trust.
If a fund has a large stake in a small company it will be made public on the company's share register. Liquidity issues will arise even if the fund manager doesn't disclose the positions themselves.
Hedge funds will be able to find the positions that open-end funds are selling, whether or not there is full portfolio disclosure. It is strange to blame hedge funds that bet against illiquid investments held by funds.
Lindsell Train Global Equity Fund - full disclosure
The Lindsell Train Global Equity fund discloses all of its positions in its annual report. This is useful as it highlights some of the smaller and more esoteric investments the fund has made.
For example, the fund has stakes in two football clubs. They appear to be odd investments and are something that investors in the fund would be interested in.
Without full disclosure, we may not have known that the Lindsell Train fund had invested in football clubs. Investors in the fund may want to question the manager on the fund's esoteric investments.
Fundsmith Equity Fund
The Fundsmith Equity Fund makes its short-form report available on its website. The long-form report lists the whole portfolio and it isn't clear if investors are entitled to receive a copy.
I have previously asked the Fundsmith help-line for the long-form report. The help-desk person typically states that they will speak to their line manager about it.
In the past, I have been sent the long-form report by Fundsmith by e-mail a few days later. After my latest request, I received a hard copy of the long-form report by post.
I am not sure if the hard copy is a security measure? Surely a determined competitor would just scan the physical report to create a PDF.
The Sunday Times article gives Fundsmith's response as follows:
1) A full list of holdings was never published on the website due to competitive reasons i.e. keeping them from the eyes of rivals.
2) Fundsmith stated that the full annual return and interim reports are available for Fundsmith investors to request.
A determined competitor would surely buy into the Fundsmith Equity Fund and then request the full annual and interim reports. I am not sure how the current system keeps the portfolio away from prying eyes.
The bottom line is that the Fundsmith Equity Fund has delivered a very strong performance since inception. Investors about performance more than full portfolio disclosure.
It does seem strange, though, that Fundsmith Equity Fund investors weren't aware that they can request the long-form report for the fund. Investors in the fund may only ever have seen its top ten holdings.
Fundsmith - Transparency
The reality is that the Fundsmith Equity Fund has been a leader on transparency.
No other open-end fund produces an "owner's manual" and holds an Annual Shareholders' Meeting. The fact sheets also disclose new positions and the monthly winners and losers.
The Fundsmith Equity Fund also discloses transaction costs. This has been something that other fund managers have been reluctant to do.
Fundsmith provides look-through portfolio metrics for the portfolio such as the operating margin. I am not aware of any other fund managers that do this.
It is interesting to compare Fundsmith Equity Fund disclosures to a passive fund. The £24 billion iShares S&P 500 ETF (CSP1) has fairly limited portfolio metrics.
iShares reveals the P/E ratio for the fund, the price to book ratio and the 12-month trailing yield. There is little key financial information beyond that.
The £17 billion Vanguard S&P 500 ETF (VUSA) also details the return on equity, the earnings growth rate and the turnover rate. There is no mention of the operating margin, the return on capital or the free cash flow yield of the S&P 500.
It is ironic that The Sunday Times criticised The Fundsmith Equity Fund for a lack of transparency. Apart from full portfolio disclosure, the Fundsmith Equity Fund appears to offer more transparency than any other fund open-end fund.
Blue Whale Fund
The Blue Whale Fund launched on 11 September 2017 and has performed well. In its Frequently Asked Questions section, the manager states that it will not declare all the holdings in its portfolio to investors.
The fund cites liquidity issues that might result from full disclosure. It appears to reference the experience of Neil Woodford in this regard.
This suggests that there is no legal requirement for open-end funds to disclose their full portfolios.
Blue Whale Fund's FAQ answer
Source: Blue Whale website
Other funds
Looking at the other funds in the Sunday Times fund list and two fail to make a full list of their portfolio available. They are Janus Henderson UK Equity Income & Growth and L&G UK Equity Income.
Nine of the other funds make their full portfolios available. Some, however, have published their full portfolios with a significant delay.
The Invesco & Growth Fund's full portfolio was last updated for the end of 2017. The Woodford Equity Income fund was fully updated up to January 31, 2009.
Woodford Investment Management has been a leader on transparency.
Is full disclosure in the interest of fund investors?
Full disclosure helps fund investors determine which funds are best to invest in. In a diversified fund, the top ten positions may only represent 20% of the full portfolio.
A look at Neil Woodford's full portfolio three years ago, for example, may have indicated that he was making a number of risky bets.
Protecting a fund from liquidity issues is in the interests of fund investors. But an open-end fund surely shouldn't be in a situation where it is open to liquidity issues.
Protecting a portfolio from rivals benefits the fund manager but doesn't have an obvious benefit for the fund investor.
I personally like to see a fund's full portfolio. Fund holdings show you how the manager is actually investing.
The recently launched Smithson Investment Trust disclosed its full portfolio in its first report. This allows fund investors to research every single position in the fund.
Small portfolio positions can reveal investments that haven't worked out or companies the manager is less certain about. They also help to build up a picture of the decision-making process.
One argument is that full disclosure may result in fund investors panicking. The media will inevitably focus on the weakest stocks and highlight how much the fund has lost on them.
This is perhaps the strongest argument that full portfolio disclosure is not in the interests of investors. I am not convinced, though, that it merits keeping the full portfolio permanently under wraps.
Are current rules fit for purpose?
It seems strange to me that a large open-end fund only has to reveal its top ten positions. Smaller portfolio positions may highlight risky bets that are unlikely to come good.
The issue with Neil Woodford's funds wasn't full disclosure, it was that poor investments were made. Transparency encourages managers to have a stricter investment approach - they have to justify every decision.
At the end of the day, the fund manager remains in the driving seat. Investors will accept less disclosure from fund managers that are able to deliver strong results.
Whether the regulator should require full portfolio disclosure is another issue. It seems odd that open-end funds only have to disclose the largest ten positions.
Personally, I am not a fan of the "trust us" approach to fund management. Funds with strong track records have occasionally gone rapidly downhill.
Full portfolio transparency would help to identify fund warning signs in advance. It would also reveal if a fund manager has enough good ideas for a 35 stock portfolio.
Smaller positions can tell you if there are enough investment ideas. The bottom of a portfolio tends to include holdings that the manager doesn't have a strong conviction on.
Why don't fund managers disclose their full portfolios?
There are a number of other reasons why fund managers may be reluctant to not disclose their full portfolios.
The top ten holdings are the manager's best ideas and will tend to have performed well. They are companies that the manager is keen to talk about.
The 35th holding in a portfolio may have been a poor investment or something just to pad out the portfolio. Focusing on the top ten allows a fund manager to control the narrative.
Weak investments can also be sold without any comment having to be made.
An additional reason is the psychological biases that full disclosure can create. Fund investors will tend to give the manager a hard time on the smaller positions that are not performing well.
This can cause fund managers to exit losing positions rather than hold on until they come good. The issue was discussed in the book "Simple but not easy" by Richard Oldfield.
There is also some mystic to not declaring the full portfolio. It implies that competitors are so eager to find out the that the full portfolio has to be kept private.
Not declaring a full portfolio has also had little impact on fund success. The Fundsmith Equity Fund has increased from less than £40m at launch to over £17 billion today.
The bottom line is that the top-ten holdings can make fund managers look like geniuses. The bottom ten can make them look like amateurs. This may explain the reluctance for full portfolio disclosure.
The Fundsmith Equity Fund has had relatively few stocks go awry as far as I am aware. Fundsmith exited Serco before it blew up.
Nevertheless, investors may only have been aware of this if they requested the full portfolio. Knowing about Serco would prompt an investor to ask: "how have you improved your processes so that you don't invest in a company like this in future?"
In my view, that is a perfectly legitimate and fair question to ask.
Why shouldn't fund investors have the information to hold fund managers to account?
Investment trusts and institutional investors
Investment Trusts have to make available their full portfolios at every interim or full-year reporting date. It is not clear that this causes an issue with regard to competition.
It is likely that large institutions are able to request up to date portfolios for the open-end funds they invest in. It is only the retail investors that are left in the dark.
Part of the rationale for Neil Woodford starting his own fund manager was for better disclosure. It would be a shame if his performance results in other managers not showing their full portfolios.
The transparency of Woodford's funds doesn't make up for a lack of performance. Investors prefer Fundsmith's results even without full portfolio disclosure. Performance is what matters.
Marketing
Instead of portfolio transparency what we tend to get are the key fund marketing messages. The trouble is that talk is cheap. The proof is in the pudding in terms of seeing the full investment portfolio.
The next best alternative to full portfolio disclosure is to construct a table of the financial ratios for the portfolio. This is what Fundsmith does for its three funds.
Fund Hunter comment
In my view, all large open-end funds should have full portfolio transparency. The competition issue could be addressed by making full portfolio updates a few months after the reporting period.
Full disclosure allows you to see what managers are doing rather than what they are saying.
No one will ever say that they have invested in a few duds. Only looking through a fund's full portfolio will bring this to light.
Subsequent articles on this issue
Daily Mail 27 April 2019 - What are they hiding? Fund firms who refused to reveal where your cash is
