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Six lessons from Woodford’s woes

Tom Stevenson

Tom Stevenson - Investment Director

Neil Woodford will not have enjoyed logging onto FT.com today. It’s unusual for an investment fund to make the headlines, let alone be the splash story of the UK’s business bible.

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It’s hard to argue against the choice of article, however. According to the FT, Woodford’s flagship equity income fund has shrunk by more than £500m in less than four weeks, a combination of redemptions and the falling value of the fund’s investments. It’s a big story.

Assets in the fund, which was valued at more than £10bn a couple of years ago, are now worth just £3.77bn. It is a dramatic fall from grace for a manager who has long been viewed as one of the industry’s stars after a successful 30-year career.

Today’s FT story says that the regulator is taking an interest in the situation, perhaps unsurprising when you consider Woodford’s profile.

At Fidelity we keep an eye on Woodford because many of our investors have backed him over the years and his funds feature in many of their portfolios. He regularly appears in lists of the most actively traded funds on our platform.

We have interviewed him on a number of occasions and he has spoken at investor events, although currently none of his funds appear on our Select 50 list of preferred funds.

So, what might we learn from Woodford’s woes? Here are six lessons:

  1. Contrarian investing is difficult. Investing against the tide places enormous psychological strain on investors. To hold your nerve and stick to your investment beliefs when the market is saying you’ve got it wrong requires great strength of character. Woodford clearly believes that weak sentiment in the UK market, particularly in out of favour sectors like housebuilders and some consumer stocks, has gone too far. He sees a big mis-pricing opportunity which, in due course, will be rewarded. But the wait for the rest of the market to catch up with his thinking is agonising. And it may never happen, of course. The biggest challenge for a true contrarian investor is dealing with the fact that you might actually be wrong.
  2. All fund managers have a bad run. There is not a single fund manager who has not been through a barren patch with their investment style. This is true of investment stars like Woodford and Anthony Bolton as much as more run of the mill managers. Hidden within the great career performance records are periods when nothing seemed to be going right. The most successful managers gritted their teeth and pushed through to better times. No-one knows when things will look up for Woodford, but no-one creates his long track record by luck alone. There’s a talented manager there who has made a number of bad calls. Probably the worst thing he could do would be to change tack now.
  3. Diversification matters. For those of us who invest in funds, as much as the managers who actually buy the shares within those funds, spreading our risk across a variety of different geographies, asset classes, styles and managers is essential. No-one has a crystal ball and the past is a poor guide to the future in investment. A balanced portfolio will ensure that a problem in one area of our investments will not sink the whole ship. Living to tell the tale is half the battle.
  4. Keep it simple. One of the problems Woodford is facing today is a mismatch between his investors expectations and how he is running his funds. Most people buy an equity income fund in the expectation that it will invest in large, secure, dividend-paying shares. A glance at the holdings of the Woodford Equity Income Fund (which all credit to Woodford are laid out in full on his company’s excellent website) shows how different it is from its peers. The traditional income payers in the oil & gas, pharmaceutical, mining and financial sectors are notable for their absence. The historic yield is a decent 4.1% according to the website but it is clearly achieved in a different way from most other equity income managers.
  5. Don’t ignore liquidity. Woodford’s willingness to invest in more obscure, less-liquid and sometimes unquoted holdings would not be a problem if the fund had met investors’ expectations and flows in and out of the fund had been within manageable bounds. Unfortunately, poor performance has led to heavy outflows which in turn have created big problems for the manager. Meeting a regulatory limit of 10% invested in unlisted stocks has become a major headache for Woodford, forcing him to employ ever more creative methods to keep within the rules. A basic rule of investment is never to become a forced seller. That’s why financial planners always advise you to keep a few months’ income in an easy-to-access cash account.
  6. Choose the right vehicle for your investments. Which leads to the final lesson from this difficult story - ensuring that you choose the right wrapper for your investments. Open-ended funds are well suited to highly-liquid investments like large shares traded on stock exchanges. They are not well suited to investments like property and unquoted shares for which it is not always possible to quickly find a willing buyer for an asset at a sensible price. The suspension of open-ended property funds in 2016 after the EU referendum taught real-estate investors a harsh lesson. The experience of Woodford has done the same for investors in unquoted shares. Ironically, Woodford understands liquidity well - it is why he set up the Patient Capital investment trust as a source of permanent capital to invest in potentially high-growth but fundamentally illiquid investments.

If you are looking for an alternative equity income investment, the Select 50 has three income-focused UK funds:

Fidelity Enhanced Income Fund. Managed by Michael Clark, this is a kind of companion fund to the Fidelity MoneyBuilder Dividend Fund. It takes the underlying portfolio of that fund and enhances its natural income by selling the right to buy some constituent holdings at a higher price to other investors. The premiums earned in this way are added to the fund’s dividend income to deliver a higher income, currently 6.8%. It should be understood that this higher income is not guaranteed and may come at the expense of some capital growth.

JOHCM UK Equity Income. This is a traditional equity income fund, holding many of the shares you would expect - the top five investments are: Shell, BP, Lloyds, HSBC, Barclays. The current yield is 5.1%.

Franklin UK Equity Income Fund. Another more standard income fund and quite a concentrated one with just 49 holdings. The top five in this case are: Shell, BP, GlaxoSmithKline, Unilever and HSBC. The yield is 4.4%.

Important information

The value of investments can go down as well as up so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. Select 50 is not a personal recommendation to buy or sell a fund.Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.