Evolution not revolution

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Mitchell Fraser-Jones 16 September 2016 Est. reading: 6 min read

As an active, pragmatic fund manager with a flexible investment mandate, it isn’t unusual for Neil to evolve his portfolios over time, as the valuation opportunity set constantly changes.

In recent months, our Woodford Equity Income Fund roundups have revealed a series of disposals of blue-chip companies, which have led to a gradual reduction in the fund’s exposure to the FTSE 100. When we launched the fund in June 2014, 57.7% of its assets were invested in FTSE 100 stocks. Over time, this exposure has reduced to stand at 46.5% as at the end of August 2016. Meanwhile, the fund’s exposure to FTSE 250 stocks, Aim-listed companies and unquoted opportunities has slowly increased. In other words, the fund has gradually moved down the market capitalisation spectrum as the opportunity set has evolved.

Chart showing concentration changes by market cap of Neil Woodford's porfolios over time

Our investment approach always represents a relentless pursuit of long-term valuation anomalies. The investment disciplines that we deploy in this pursuit are consistent: a strong macroeconomic view informing high-conviction, valuation-based stock-picking, coupled with a strong focus on absolute risk and long-term fundamentals. Over time, however, these same investment disciplines have resulted in drastically different portfolios. Neil has utilised the full flexibility of his investment mandates to build distinct strategies to suit varying market conditions and, most of the time, portfolios that look nothing like the UK market as a whole. After all, as Sir John Templeton famously once said, “It is impossible to produce superior performance unless you do something different from the majority”.

Let’s travel back through history to see how Neil’s portfolios have evolved over time. The first real example of Neil building a portfolio that looked (and ultimately behaved) very different from the broader UK market was in the early 1990s. His portfolios then bear very little resemblance to the portfolios he manages now. At that time, Neil had positioned his portfolios full of domestic cyclical businesses, primarily engineering and export-focused stocks but also retailers, leisure companies and real estate.

At the time, these stocks were incredibly cheap and getting cheaper. After a prolonged period of consumption-led growth in the “Lawson Boom” years, the UK economy had ground to a halt. The government of the time should have been pursuing policies to revive it but instead it made things worse. The Conservative administration, led by John Major, was intent on maintaining the UK’s membership of the European Exchange Rate Mechanism (ERM), a preparatory fore-runner of the region’s single currency, the euro. As a ‘semi-pegged’ exchange rate system, all member states of the ERM had to pursue policies that would keep their currencies tied in a tight band to the deutschmark.

We often talk about exploiting market irrationality in our portfolios but this was really an example of exploiting political irrationality – trying to maintain Britain’s membership of the ERM with the UK economy gripped by recession was the economics of the madhouse. Essentially, government policy was defying economic wisdom by raising interest rates (and using FX reserves) to boost the value of sterling, when the UK economy was screaming out for much lower interest rates.

George Soros became famous as “the man that broke the Bank of England” but essentially, Neil was shaping his portfolios to benefit from the same outcome – both of them developed high conviction views that the UK government would fail in its attempt to maintain Britain’s membership of the ERM. Neither knew how or when but both recognised the situation as unsustainable. In September 1992, on Black Wednesday, the UK withdraw from the ERM, and an immediate reduction in interest rates followed, along with a dramatic rally in the share prices of all things cyclical on the UK stock market. The funds that Neil was managing at the time leapt from the bottom of the fourth quartile to the top of the first quartile and stayed there for some time.

Today, we live in a different world – a very different economic environment and a very different valuation opportunity set. There have been various shades of portfolio in between, of course – be it a substantial weighting towards banks (yes, you did read that correctly) in the mid-nineties, or the ‘old economy’ stocks that were totally out-of-favour during the dotcom bubble, or the focus on global dependable growth that developed in the run-up to the financial crisis.

All of these portfolios were formed using the same tools and with the same aim – that of delivering attractively positive long-term returns to investors. In each case, they ultimately succeeded in that aim.

The equity income fund has evolved in the relatively short period since its launch but it continues to reflect the cautious view we have of the global economic outlook. We remain absent from the parts of the market that look most vulnerable to the economic headwinds and have focused the portfolio towards companies that can deliver sustainable growth in spite of them. Some of the larger cap businesses that have exited the portfolio still look capable of delivering growth but other opportunities, some of them in smaller, earlier-stage businesses, have surpassed them in terms of attractiveness and conviction.

This evolution will inevitably continue. The pace and direction of that change is impossible to predict, as it will depend on what happens in markets and in the global economy.  One thing we can be sure of, however, is that Neil will continue to invest with the same discipline and with the same aim of delivering the attractive long-term total return that investors expect. An attractive, sustainable and growing income stream will continue to be a vital part of that return.

What are the risks?

  • The value of the fund and any income from it may go down as well as up, so you may get back less than you invested
  • Past performance cannot be relied upon as a guide to future performance
  • The ongoing charges figure is charged to capital, so the income of the fund may be higher but capital growth may be restricted or capital may be eroded
  • The fund may invest in other transferable securities, money market instruments, warrants, collective investment schemes and deposits – some of these security types could increase the fund′s volatility and increase the level of indirect charges to which the fund is exposed
  • The fund may invest in overseas securities and be exposed to currencies other than pound sterling – as a result, exchange rate movements may cause the sterling value of investments to decrease or increase
  • The fund may invest in unquoted securities, which may be less liquid and more difficult to value, because they are generally not publicly traded – the lack of an open market may also make it more difficult to establish fair value

Important information

Before investing, you should read the Key Investor Information Document (KIID) for the fund, and the Prospectus which, along with our terms and conditions, can be obtained from the downloads page or from our registered office. If you have a financial adviser, you should seek their advice before investing. Woodford Investment Management Ltd is not authorised to provide investment advice.

The Woodford Funds (Ireland) ICAV (the “Fund”) has appointed as Swiss Representative Oligo Swiss Fund Services SA, Av. Villamont 17, 1005 Lausanne, Switzerland. The Fund′s Swiss paying agent is Neue Helvetische Bank AG. All fund documentation including, Prospectus, Key Investor Information Documents, Instrument of Incorporation and financial reports may be obtained free of charge from the Swiss Representative in Lausanne. The place of performance and jurisdiction for all shares distributed in or from Switzerland is at the registered office of the Swiss Representative. Fund prices can be found at www.fundinfo.com.

Woodford Investment Management Ltd is authorised and regulated by the Financial Conduct Authority (firm reference number 745433). Incorporated in England and Wales, company number 10118169. Registered address 9400 Garsington Road, Oxford OX4 2HN.

Woodford Patient Capital Trust plc is incorporated in England and Wales, company number 09405653. Registered as an investment company under section 833 of the Companies Act 2006. Registered address Beaufort House, 51 New North Road, Exeter, EX4 4EP.

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