As you may have read some negative coverage in the press about the Woodford Equity Income Fund, I thought you might be interested in the current views of Square Mile, our research partner, who are in regular contact with Neil Woodford and his team. I also attended an update session with the manager last week and would like to share my insight.
As a reminder, the Fund is managed in a contrarian manner and with a long-term mind-set. However, since the summer of 2017, performance has been hampered by problems in a few investee companies, notably credit lender Provident Financial and out-sourcing specialist Capita. Furthermore, stock markets have been driven by momentum in certain sectors to which the Fund does not have exposure.
Square Mile backs strategy
While not unconcerned about these issues, Square Mile is satisfied that this setback is a feature of investing with a Fund Manager who takes high conviction positions. When a portfolio is truly actively managed, a period of under-performance is to be expected from time to time. It is also important to consider recent problems in the context of a career spanning more than three decades. There have been occasions in the past when Neil has been at odds with the market in his views for an extended period. For example, prior to the ‘dotcom bubble’ bursting in 2000, and before the financial crisis of 2008.
Above all, Neil seeks to invest in companies whose share prices, in his view, do not reflect the true value of their underlying businesses. As such, these firms may be suffering from negative investor sentiment, which can persist for some time. He is certainly not complacent about recent performance but feels the overall dispersion of stock valuations is at its widest level since 1999-2000. What’s more he considers certain companies are at their cheapest valuations for over 30 years. As a contrarian, he has positioned the portfolio towards more domestically orientated companies, believing that the negative implications of Brexit have been overdone and many stocks are pricing in an 'Armageddon-like' scenario. A view he clearly does not subscribe to.
Overall, Square Mile are satisfied that there are no endemic issues with how the Fund is being run. They have found Neil to be as committed and passionate about investing as ever. Given that Neil’s long term track record, including previous portfolios that he has managed, is exemplary they maintain their conviction in his Fund management capabilities and keep the rating at AAA. As Square Mile rate Funds on expected performance over an investment cycle of 5-7 years, if the strategy proves correct there is still time for the Fund to re-coup relative losses and get performance back on track.
Is the Fund poised to resume out-performance?
I attended a round-table event where there was the opportunity to pose questions to Neil and gain a better understanding of his approach. It was clear he is sticking to his guns and is more convinced than ever that a turnaround in market leadership from expensive stocks to the deep value stocks that he favours is imminent.
My main caveat is that investors must understand what they are buying into. The Fund adopts a bar-bell approach, meaning income is generated from a core of large, Blue Chip companies plus some smaller stocks where a large stake may be held. There is also a quota of early stage, unquoted securities which are inherently higher risk, and a few should be expected to fail, but are held for their significant capital growth potential. Indeed, just one runaway success, like Purplebricks (bought when a private company and now listed on the AIM market) can provide a significant boost to performance.
Neil is less convinced than some that synchronised global growth driven by reflation will persist and is particularly nervous about China. On the other hand, he thinks the UK will beat lowly expectations as wage growth revives and consumer confidence returns. He is convinced that improving fundamentals for the UK market, and recognition of the ‘cheapness’ of some out of favour sectors will favour his value style. His personal opinion is that the ‘growth bubble’ will deflate in 2018.
Clearly, this is a higher risk strategy than some other income Funds and individual stock selection of late has not been as good as one might have hoped from a manager of Neil’s calibre. He concedes that he cannot eliminate price setbacks in what is unarguably a volatile asset class, but says ‘we do our upmost to avoid a temporary loss of capital becoming a permanent one through the careful and disciplined consideration of the fundamentals.’
When a stock disappoints, the team (3 Fund Managers and 3 specialist sector analysts) revisits the investment case and if the long term investment proposition remains valid then he averages down. That said, if the investment thesis no longer stacks up or the fundamentals have changed then he will sell. Recent disposals on such grounds include: BT, Royal Mail and Lancashire Holdings. The unquoted portion of the portfolio (currently close to its 10% permitted maximum) is revalued periodically and the team believe there is plenty of latent value in the holdings.
Not all bad news
To give Neil some credit, it should be acknowledged that problematic stocks can turn around very quickly. When Provident Financial, one of the main detractors over the past year, settled a dispute with the regulator and raised new money, its share price rose 70% in a day. The smaller stocks can also move dramatically on some good news. For example, New York listed bio-technology company Prothena recently soared over 20% on news of a development collaboration which brings a large cash injection and a potentially healthy future stream of royalties.
There have obviously been questions over the sustainability of the Fund’s dividend, given that a number of holdings have cut or suspended their pay-outs, and the unquoted stocks generally do not pay dividends. The aim is still to grow the income each year. I have been assured that Neil is anticipating the Fund's distribution to grow by around 5% in 2018 and I agree, as do Square Mile, that this achievable. However, the Fund has been removed from the IA Equity Income sector for failing to deliver a 3 year average yield above that of the FT All Share. It now sits in the UK All Companies sector and the yield stands at a respectable 3.8% at the time of writing.
: Willis Owen do not give investment advice so you will need to decide if an investment is suitable for you. If you are unsure whether to invest, you should contact a financial adviser.