As we welcome Mike Lea to the FPC team this month we invite him to share his thoughts on the continuing Woodford saga and what lessons we can learn from it. Mike joins us with over a decade of experience in investment management and will be a regular contributor to our news in the future…
Information overload is prevalent in the modern investment world and can make looking at the bigger picture difficult. However, it remains crucial that the finer details of any investment decision be given due consideration to avoid being caught off guard.
Over the past month investors and the media have focused on the suspension of the popular Woodford Equity Income fund, run by ‘star’ manager, Neil Woodford. The story continues to unfold, though a temporary halt has been placed on investors realising their capital due to liquidity issues within the underlying shareholdings in the fund. The fund will remain closed until 1st July when an update to investors will be made.
First of all, we would like to emphasise the point that FPC clients do not have exposure to this fund and so are unaffected by this event.
So who is Neil Woodford?
Neil Woodford is undoubtedly a highly experienced and influential fund manager who is well respected across the industry. He originally became a name at Invesco Perpetual, where he managed £30bn of assets across the Income and High Income funds. His investment style is one of being a contrarian, conviction, value based investor (acquiring out of favour assets with present values perceived to be below their intrinsic worth), which naturally led him to avoid participation in the dot-com technology boom in the late 90s.
In 2014, under much fanfare, he left Invesco and founded Woodford Investment Management, duly followed by an army of retail investors (fearful of missing out on future performance) and large institutional mandates (fearful of being seen to be missing out). This was a major market event.
Blinded by the Lights
Alongside the birth of the open-ended Equity Income fund was a listed closed-ended investment trust named Patient Capital, promoted with the opportunity to participate in early stage unlisted companies with an ‘innovative’ performance-based fee structure. Some of these same companies quietly found a home in the Equity Income fund, as the manager used his permissions to add up to 10% of unlisted investments. Whilst this is not against the rulebook, it is not your typical Equity Income strategy.
The Equity Income fund quickly gathered over £10bn in assets in under 3 years. The Patient Capital trust initially traded at a double-digit premium to the share net asset value (NAV), demonstrating confidence in the manager, as investors effectively paid more for the shares than what they were worth had the portfolio been sold.
Under-Performance
Performance of each fund to date has been very poor indeed. Without focusing on the numbers, what transpired is that the environment has not been conducive to Mr Woodford’s investment style, no matter how ‘skilled’ investors believed him to be. Core listed companies held in the fund such as Kier (construction), Provident Financial and AA to name a few, have moved from being not just out of favour by the market, but despised, resulting in significant falls in value. The conviction approach shown, on this occasion, has worked against the manager.
As poor performance became evident, investors in the Equity Income fund took notice of the portfolio positioning, focusing on the unlisted investments that had become more prominent. As discomfort increased, investor redemption (sale) requests started to snowball, including a £250m instruction from Kent County Council. The manager has simply been unable to raise the funds required to repay investors hence, in order to ‘protect’ the fund, investors were told they cannot access their capital. Against such a tidal wave of redemptions there was little other option available.
Forced Restructuring
The manager is now in a period of re-positioning the portfolio, admitting it will not resemble the same fund after the suspension as it did before. For those investors locked into the fund, the changes being made to the portfolio are being forced, with disposals that the manager would otherwise not have ideally wanted, simply to meet liquidity requirements.
Being handed large investment mandates is exhilarating, but losing them is painful. On the back of the suspension, advice firm St James’s Place also removed a £3.5bn segregated mandate they had tasked Woodford with managing. Hargreaves Lansdown is another high profile firm that supported the Equity Income fund and they have also removed it from their recommended list. It does all seem a bit reactive though, as in performance terms the horse has long bolted from the stable.
The Patient Capital trust does not have the same liquidity issue nor objective, but sentiment has similarly suffered as shown by the large discount of the shares to NAV, as against the premium that previously existed. There are cross holdings between the two funds, so the fear here is that forced selling of investments in the Equity Income fund will depress the NAV further.
In defence of the fund manager, he has stuck steadfast to his investment principles and was perfectly entitled to invest up to 10% of his fund in unlisted securities, which was disclosed in the initial fund documentation. This was seemingly overlooked by investors given that Mr Woodford was in charge.
The Impact
It will be difficult for Mr Woodford to recover from this period. Having to weather such a storm after a career of high praise and adulation must surely have an impact psychologically. Investors are an unforgiving bunch and market sentiment over his stock picking abilities will remain negative for some time.
“Most investors’ results will be determined by how many losers they have, and how bad they are, than by the greatness of their winners” (Howard Marks, The Most Important Thing, Columbia University Press, 2013).
It is irrelevant to now debate whether Mr Woodford is a ‘skilled’ fund manager or not, or to vilify him, as the media has, for his recent investment performance. Experienced and knowledgeable fund managers who perform well over defined periods do exist, but only when their investment style aligns with what the market values. As for being a ‘star’ manager, such a title does not exist.
There is nothing wrong with operating a niche investment strategy, but investors have to understand the increased risks that might exist, such as the difficulty in realising the value of unlisted, or illiquid investments. Choosing a fund manager should only be part of a much wider investment process and focusing on the finer investment details does indeed matter.
FPC’s Investment Management Approach
FPC have a rigorous investment process focused on ‘winning by not losing’, with robust due diligence carried out on all investments within client portfolios. Ongoing monitoring is of utmost importance and new, innovative, or niche investment opportunities are held under far greater scrutiny. There is a place for active fund management as part of an overall investment strategy, but it is important to understand exactly what is being invested in, and what the expected outcome might be. Traditional investment principles of long term investment horizons and diversification continually hold true.
As always, should you have any concerns or queries please don’t hesitate to contact us. Visit our website to find out more about FPC’s investment philosophy and Mike Lea. We look forward to introducing him to clients and our professional connections over the coming months…
