The Woodford investment process is rigorous, circular and continuous. There are no set criteria for stock selection and investment decisions are relentlessly revisited to ensure their continuing relevance and appropriateness.
We have a broad-based approach to idea generation. Some are internally generated, while others are identified through proprietary analysis and external research from a wide range of sources. Many originate from our extensive interactions with the wider investment industry and through our conversations with company management teams. We also have an extensive network of historic relationships that regularly bring new ideas to our attention.
Our network is especially important when identifying suitable early-stage business investment opportunities. We have cultivated close and collaborative relationships with a trusted group of organisations and individuals spanning the full range of skills needed to take a business from seed to commercialisation and covering multiple industry sectors and geographical locations. This includes tech transfer specialists, leading academics, venture capitalists, successful entrepreneurs, development-stage and commercial executives, investment banks and retired executives and experienced board members. We use our network to share ideas, reinforce due diligence, secure specialist technical advice and tap into commercial acumen. It is a partnership network that is unique to us – and one that continues to grow.
Having a comprehensive, fundamental understanding of the long-term macroeconomic outlook (the bigger economic picture) is a critical part of our investment approach. However, this does not involve trying to precisely forecast macro variables. More, it is about evaluating the likely direction of those variables and trying to understand the key drivers of growth, inflation, labour markets, liquidity and trade, among other things. If we can understand the long-term direction and influences of these variables, we believe we can make better long-term decisions.
This long-term view of the bigger economic picture helps to direct our research efforts and inform our assumptions and judgements on all investment opportunities. The view is of more importance when judging the attractiveness of mature businesses as the fortunes of earlier-stage businesses are naturally determined more by their own fundamental progress.
Over-arching all of our research efforts is a desire to be as comprehensive as possible in our understanding of a company’s fundamentals (its actual operating performance including its ability to deliver growing revenues, profits, cashflow and dividends). We consider inputs from a wide range of sources, with the aim of reaching informed investment decisions that will add long-term value for our investors.
Quantitative analysis plays an important role in our investment process but needs to be considered in conjunction with many other more important qualitative judgements, including:
- Do we have confidence in the executive management team to deliver on their long-term objectives?
- Is management aligned with shareholders?
- Are margins and cash flows sustainable?
- What long-term growth can this company deliver and how will it fund that growth?
- Are there any regulatory, legal, political or other threats to this company and its industry?
- Does the price that we are being asked to pay for a stake in this company represent compelling value?
When investing in early-stage businesses, the analysis is particularly detailed and aims to demonstrate that the management team’s account of the attractions of the business can be evidenced by fact.
Initial investigation involves the team looking at the business area the company operates in, intellectual property and technology, patent estate, products and services, financial characteristics and management team. We also consider market size, commercial opportunity, competitive environment and risks.
During the next stage of the process – detailed due diligence – we undertake site visits, meet the wider team, talk to potential customers, suppliers and analysts, carry out detailed scientific diligence, engage with industry specialists to better understand the technology and science and the competitive context, commission detailed intellectual property reviews, undertake extensive financial modelling, check underlying assumptions and complete a comprehensive review of valuation, based on a longer-term investment time horizon.
Around half of the companies on which we complete due diligence will be approved for investment and enter the final pre-investment stages of legal process and final approval. In this stage, we conduct more technical diligence on companies as required (covering subjects such as financials, intellectual property, legal, tax and anti-money laundering) and submit to the company the investment terms on which we are prepared to invest.
Meeting company management teams is a vital part of our investment process and responsibility for it sits with the investment team. For us, corporate governance is about ensuring that the executive and board of a company are aligned with us as shareholders and that the course that they have set for the business will create long-term shareholder value. If we fear that this alignment does not exist or feel that an alternative strategy may result in the realisation of more shareholder value, we will engage with management to try to influence change. Unlike many investors in today’s market, we favour voice over exit.
We meet with management teams regularly – typically at least twice a year after the release of financial results but more frequently where the need arises. These meetings are an invaluable source of information in the conviction building process, which in turn leads activity.
We are necessarily highly engaged with the management teams of the early-stage businesses in which we invest – although not so involved that we influence day-to-day decisions. For our private investments, a combination of board meetings, board packs and quarterly management reviews ensures we stay current with our investments from the perspective of monitoring – for oversight and valuation purposes. If we identify an issue, we become more engaged, trying to get to the root cause and encouraging the business to address this through a number of means. We hold each company to account to make sure it achieves the milestones we have set. If it does, we put more capital to work and if it doesn’t, we stop or withdraw funding.
The construction of the portfolio is the sole responsibility of the fund manager, Neil Woodford, with other members of the investment team assisting in information gathering, analysis and implementation.
The aim of all of our research efforts is to arrive at an informed judgement about long-term value so that we can assess whether the investment opportunity is attractive enough to include in a portfolio. There is always intense competition for capital within portfolios, so a new investment opportunity has to fight for attention and prove its credentials alongside existing positions.
Portfolio construction is entirely a product of stock specifics – the fundamental attractions of each individual investment and the level of conviction in each opportunity. It is not by reference to any index or sector preference. Each stock is included in a portfolio on its own merit – we do not hold positions purely to manage relative risk. Portfolio weightings are determined by the level of conviction in an investment thesis and our judgement of the balance between the potential upside to true inherent long-term value and the risks that may stand in the way of that long-term value being realised.
All of this is informally balanced against a desire to be sensibly and appropriately diversified at a stock and sector level, in pursuit of a portfolio that can deliver attractive long-term risk-adjusted returns.
For early-stage investing, when we first invest, it will be with a typical time horizon of somewhere between three to five years, split into funding more discrete 18-24-month business plans. If a business is successful, a 10-15 year holding period is entirely possible. The largest portfolio positions are typically those where the company is furthest along the development or commercialisation path. The earlier the stage a company is at, the further from technology or commercial validation, the smaller the position is likely to be – due to the greater risk and because we foresee multiple future funding rounds, in which we may wish to participate to build the position as the level of risk decreases.
Monitoring of portfolio holdings is a continuous process and is primarily the responsibility of the fund manager, assisted by the rest of the investment team. All portfolios are reviewed daily to ensure appropriateness, consistency and adherence to the mandate, including any relevant restrictions. Individual holdings are assessed and monitored daily for news flow and relevant conversations with brokers and directly with the company.
A decision to sell tends to be formed around three, often inter-linked factors:
- A judgement that a stock’s valuation has started to look less attractive (the gap between ‘value’ and ‘price’ has been discovered)
- An event such as financial results or an acquisition changes our view of the company
- A stock starts to look less attractive than other investment ideas that are competing for a place in the portfolio
These factors will always dominate a decision to sell or reduce a position, unless we are mandatorily required to sell (for instance, if we could exceed the maximum permitted size due to share price movements or in a bid situation).