Issue 206: 2019 06 13: Woodford Investments

13 June 2019

Woodford Investments:  Don’t Blame It On The Sunshine

Investors should self-examine

by Frank O’Nomics

Few people truly understand investment markets, but many want to earn as much money from their savings as they can, and as quickly as possible.  Why not then turn to a man who in the past generated a total returns for investors of 2000%?  This was what drove the £10bn+ of investments into Neil Woodford’s funds when he started a new company in 2014.  Not surprisingly these investors are bitterly disappointed at Mr. Woodford’s poor performance over the past 5 years.  After a strong start his flagship Equity Income Fund has underperformed the market considerably, losing almost 20% year-to-date, while his Patient Capital Fund has lost 38% over the last 3 years, all against a backdrop of a strongly positive return from the FTSE 100.  Perhaps more importantly, this underperformance has occurred at a time when other star fund managers, previously regarded as his peers, have done exceptionally well.  Terry Smith’s Equity Fund has returned 14% and Nick Train’s UK Equity Fund has delivered 10% over the past 12 months.  What has really riled investors is that, with so many trying to get their money out, the fund has been closed to redemptions.  This combination of poor performance and no facility (in the short-term) to get out has not surprisingly left investors looking for someone to blame.  Surely Mr. Woodford has gone against some of the cardinal tenets of sound investment?  Shouldn’t regulations have been more robust either to stop Mr. Woodford adopting such a gung-ho investment style or to stop fund intermediaries promoting the funds as a sound investment?  These criticisms may have a degree of validity but they miss one critical area – the investors themselves.

Let’s start by giving the underlying investors the benefit of the doubt and examine where Mr. Woodford may have gone wrong.  Many argue that he took in too much money too quickly, particularly into funds focused on small, difficult to trade, stocks.  It is further argued that he mixed his investment styles, by putting some of the small cap stocks into the Equity Income Fund.  While these arguments make seem to make sense now, there is some post-event rationalisation going on.  Firstly, for funds that are targeting growth, early stage investments are those that carry the biggest risks and  rewards.  Data released this week shows that the UK is the biggest generator of “unicorn” companies – many of those big ideas have realised their potential.  For a value driven growth fund manager, who believes that there is little value left in developed equity markets after a 10 year bull run, it seems entirely reasonable to look for value elsewhere and to try to find such unicorns.

There are undoubtedly some arguments which suggest that Neil Woodford’s change of investment approach has failed, but what of those who claim that either those promoting his funds, or the regulator, should have stepped in?  There is no evidence that regulations have been contravened, so the better question is what needs to be changed.  The chief executive of the FCA has acknowledged that it does not make sense to allow daily dealing and redemptions in open-ended funds that hold a large proportion of illiquid assets, and this hints at potential rule changes.  In addition, the ability to list some illiquid investments overseas is likely to be challenged on the grounds that investors should have a say in where there investments are listed.  What is not clear, however, is whether if stricter rules had been in place it would have stopped those avaricious investors chasing their dream regardless.

Now for the big question – one which needs some self-reflection by the investors themselves.  For individual investors there may be some sympathy, particularly for those who had done so well by loyally sticking with Mr. Woodford while he was at Invesco.  In what has been a long bull market they were not unreasonable in expecting continued outperformance.  Nevertheless, anyone who buys into active funds should do so in the full knowledge that past performance is no guarantee of future returns – they are all told this repeatedly when they make an investment.

Further, a significant part of Woodford’s funds under management come from seasoned sophisticated institutional investors, and advisors who invest on behalf of large groups of individuals – both groups more than capable of assessing his investment strategy and of working out how long it can take to unwind early stage investments.  It is not as if he hides the list of stocks in his portfolio – unlike some funds they are clearly listed for all to see.

Kent County Council currently has £263mn of its pension fund trapped in Neil Woodford’s funds – it is trying to get its money out, but should it have expected this investment to be a liquid part of its portfolio?  For one area of Woodford’s funds the clue is in the title – the whole point of “patient” investment is that it takes time for companies to fully fledge and returns in the interim are quite likely to be disappointing.  It is fair to argue that moving some of these investments into an equity income fund is counter-intuitive, but can be supported on the basis that they were long-term growth prospects and not dissimilar to when a fund manager moves into cash (which generates almost no income) as a defensive play.

The search for blame in this instance unearths many suspects and there is widespread culpability.  Much of the responsibility must lie with a fund manager who took risks that have – at least hitherto – have not come off.  There has been a lot of ill-informed talk of just how much Mr. Woodford has been earning from the management of the funds (a number considerably lower after funds under management shrank from £10bn to £3.7bn), but it is not unreasonable that investors might expect some kind of fee discount – at least until a high water-mark of returns is achieved.  For now there may be a more interesting question.  For so many years Neil Woodford was a very successful fund manager, and these skills have not just disappeared along with his fund’s quotation.  Given the opportunity to buy into the funds at a discount to net asset value, which for the Patient Capital Fund has been close to 30%, some may be tempted to continue to back him.  However, if they do, and it doesn’t come off – they will only have themselves to blame.

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