5th June 2014
Mick Gilligan, head of research at fund and stockbrokers Killik & Co gives his verdict on Neil Woodford’s upcoming portfolio launch – the CF Woodford Equity Income Fund.
Woodford is one of the most renowned UK fund managers, having delivered market-beating returns for the Invesco Perpetual Income and High Income Funds between 1988 and 2014. Woodford started managing the Invesco Perpetual Income Fund in October 1990 and formally gave up management in May this year. Over this period the fund generated a 14.3% annualised compound return, significantly ahead of both the FTSE All-Share TR Index return of 9.6% and the IMA UK Equity Income Sector average return of 9.3%. The return was achieved with significantly lower peak-to-trough losses during 2008/09 and with lower overall volatility than both comparatives.
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Woodford left Invesco earlier this year and has formed a new fund management business, Woodford Investment Management. The firm’s first fund, the CF Woodford Equity Income Fund is now in its initial offer period and first day of trading will be the 19June. The new fund will follow the same investment process as the Invesco Perpetual Income Fund. It will seek to provide investors with long-term appreciation by investing in stocks, which are primarily listed on UK stock exchanges, whilst also investing up to 20% in non-UK listed stocks.
The fund will aim to generate an income yield that is 10% higher than that of the FTSE All Share Index, translating to a current yield of 4.0%. Income will be distributed quarterly. The investment process primarily seeks to identify stocks where the manager believes the market has mispriced the value of the company’s prospective cash generating ability, within the prevailing macro environment. The manager will invest in stocks that fit these criteria where he believes this market view will adjust over time, resulting in a higher share price.
The starting portfolio of the new fund is likely to look very similar to that of the old fund. That is, there is likely to be a large portion – possibly 50-60% – invested in the top 10 holdings. There is also likely to be a long tail of less liquid quoted and unquoted shares, which the manager believes have strong long term growth prospects.
The “early-stage business” element is likely to be 5-7% of the portfolio. Woodford continues to see value in the tobacco and pharmaceutical sectors and these are likely to feature prominently in the new fund. As with Invesco Perpetual Income, the new fund is likely to make full use of its 20% non-UK listed “quota”. The Invesco fund used this flexibility to hold stocks like Reynolds American, Roche and Sanofi. The fund is unlikely to have any exposure to Food Retailers. Woodford sold his position in Tesco more than two years ago and sold the William Morrison holding last year.
He sees this sector as being cyclically challenged by the squeeze on the middle-income bracket by the growth of discount retailers and structurally challenged by the advent of home delivery and the internet. His current view is that both challenges have yet to play out sufficiently to encourage any “bottom fishing”. He fully expects the grow rate of the Chinese economy to slow, which is a negative backdrop for commodities, and as a result there is likely to be little or no exposure to Mining and Oil & Gas.
One of the key differentiators of Woodford’s investment approach has been the importance placed on the macroeconomic backdrop as an influence in portfolio construction. The manager believes that quantitative easing has pushed asset prices, including share prices, higher than is justified by either economic or corporate fundamentals. He therefore sees less valuation support and therefore more risk in share prices than five years ago. However, the fund is likely to be close to 100% invested from launch and Woodford still sees sufficient stock specific opportunities for those with a reasonable medium term time horizon. The manager expects stock fundamentals to matter more over the next five years than they have over the last five years as quantitative easing tapers down and the impetus behind asset inflation diminishes.
The key risks that we foresee with this fund are the same as investing in any stock market based investment – i.e. the volatility that comes with equity investing and the risk of capital loss in the short term. However, we think this is likely to be less pronounced in the Woodford Equity Income Fund than with most of the UK Equity Income peer group. That aside there is the potential performance drag if the market gets driven higher by sectors that the manager has little or no exposure to (e.g. Mining, Oil & Gas, Banks).
Woodford has steered his portfolios competently through a number of very different market conditions over the last 25 years or so. If we take the 23-year period that he managed the Invesco Income Fund and divide it into lots of three-year time frames we get 249 separate investment periods (based on monthly observations). The Invesco fund produced a positive return in 226 of these observations (i.e. 91% of the time) and the worst possible three year outcome was -4.9%. This is significantly better than the comparable figures for the FTSE All Share Index (77%, -15.4%) and the IMA UK Equity Income Fund (78%, -12.2%).
He looks to be building an asset management business that is capable of perpetuating this performance profile. One potential advantage the new fund may have over the previous fund is the scope to cherry-pick new investments and a lack of any legacy issues, although it may be some time before the magnitude of this potential advantage becomes apparent. We expect this manager to continue producing market-beating returns over the medium to long term.
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