The final month of 2016 marked the end of a difficult year for the fund. Equity markets performed well, with continued positivity about the prospect of a Trump presidency, further weakness in sterling and a higher price of oil combining to send the FTSE All Share index to an all-time high at year end. Meanwhile, the Federal Reserve’s move to increase US interest rates by 0.25% was widely anticipated and did little to dampen investors’ optimism. Against this background, the fund delivered a positive return but trailed the broader market over the month.
The portfolio’s healthcare holdings delivered a positive contribution in December, following several weeks of negative sentiment prompted by the US election campaign. Among the best performers were the portfolio’s large pharmaceutical holdings, AstraZeneca and GlaxoSmithKline, with both helped by positive pipeline developments. In AstraZeneca’s case, the company announced that the FDA has accepted its application to treat bladder cancer using durvalumab, an immuno-oncology asset with significant potential. We expect further positive announcements from trials involving durvalumab, as 2017 progresses. AstraZeneca also released some very encouraging clinical data from the Phase III trial of Tagrisso, its potential lung cancer treatment. Meanwhile, GlaxoSmithKline announced positive developments for its Closed Triple* therapy, filing it for approval in the EU as a chronic obstructive pulmonary disease treatment and starting a Phase III trial in asthma.
Elsewhere, Drax performed well after the company announced the acquisition of Opus Energy, a business-to-business energy supplier. The move furthers the company’s strategy of focusing its energy distribution business on small and medium-sized enterprises, which provide a higher-margin opportunity than large, industrial customers. The company also received approval from the European Commission to operate its third biomass unit conversion under a Contract for Difference, which gives it increased visibility over its future revenue streams, courtesy of a strike price. This news allows Drax to help the UK towards meeting its legally-binding carbon reduction targets in a cost-effective manner, whilst also helping to ensure security of supply by providing dispatchable power that is available when required. No other renewable energy technology offers this combination of benefits.
Another notable positive contribution to performance came from Allied Minds. During the month, the company raised further capital via a placing in which we participated, alongside a combination of other existing and new investors. This puts Allied Minds in an even stronger position to create value for its shareholders by capitalising on investment opportunities and further developing its portfolio of exciting and innovative young businesses.
By contrast, security firm G4S and sub-prime lending specialist Provident Financial detracted from performance. US biotech Prothena, whose shares have been volatile this year, also weakened. In each instance, we can see no fundamental reason for the share price declines and remain very confident in the long-term investment cases.
There was a fundamental disappointment, however, from Capita during the month, in the form of another profit warning. With the benefit of hindsight, it has been a mistake to own Capita shares within the portfolio over the last twelve months – that is evident in the fact that its share price has fallen from over £11 per share at the start of 2016 to below £5 per share at times during December. However, as we said in our year in review article, it is critical that we do not compound that mistake through an emotional reaction to the disappointment of the share price fall. Our view is that the market has over-reacted – to an extent, understandably – to this series of negative trading updates. In turn, this has driven Capita’s share price way below the intrinsic value of the business. We have, therefore, retained conviction in the long-term investment case and took advantage of the depressed share price to add to the fund’s position in the company.
Elsewhere, we added to Drax, British American Tobacco and AstraZeneca at what we believe to be very attractive valuations. We also provided a small tranche of additional funding to Mission Therapeutics, following further pipeline progress and Oxford Nanopore as it moves through the early-stages of commercialising its revolutionary gene-sequencing technologies.
As we head into 2017, it is worth remembering that, sometimes, share prices may rise and fall for reasons that have nothing to do with fundamentals. Much of what we saw in 2016 does not appear to be fully-explained by fundamentals. In the long run, they are all that matter for share prices, but over shorter time periods, they can be rendered almost irrelevant, as other drivers, such as sentiment and momentum, take over.
When this happens, it is important that we stick to our investment disciplines, revisit our basic assumptions and if they continue to hold true, maintain conviction in our strategy. In so doing, we remain very confident that the fund is appropriately positioned to deliver very attractive long-term returns as fundamentals reassert themselves, which they inevitably will.
* A combination of three respiratory drugs into one
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The views expressed in this article are those of the author at the date of publication and not necessarily those of Woodford Investment Management LLP. The contents of this article are not intended as investment advice and will not be updated after publication.
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