Fund roundup, July 2016

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Mitchell Fraser-Jones 12 August 2016 Est. reading: 5 min read

The UK market continued its post-referendum recovery in July, having quickly concluded that the UK’s vote to leave the European Union is not as big a deal for the economy or stock market as initially feared.

Nevertheless, equity markets remain remarkably complacent about some of the bigger issues facing the global economy. Debt, ageing demographics, deflation and a disturbing lack of productivity growth are among the factors that have been worrying us for some time and that the bond market appears to be pricing in more appropriately.

The fund delivered a solidly positive return during the month, assisted by the market’s more rational perspective towards Brexit. Having remained weak during the first few days of July, shares such as Legal & General and Provident Financial performed very well as the month progressed, delivering a positive contribution to performance. Both of these stocks were helped by a calmer market which has started to value their healthy, cash-generative revenue streams more appropriately. We remain very attracted to both businesses believing that the market still fails to value their long-term growth prospects.

Not all market movements appeared entirely rational, however. There was a distinct difference between the fortunes of our large pharmaceutical and tobacco stocks, for instance. All of these businesses had delivered very strong performance during late June but, although the likes of AstraZeneca and GlaxoSmithKline continued to perform well, large tobacco stocks such as Imperial Brands and Reynolds American retraced some of their earlier gains. This performance disparity is difficult to explain and is not linked to any deterioration in fundamentals. We remain attracted to all of our exposures in these sectors.

The most significant individual contribution to performance came from US biotech, Prothena. Early in the month, the company announced very encouraging trial data from its Phase I/II study in NEOD001, its potential treatment for AL amyloidosis. This provided further convincing evidence of the drug’s effectiveness with excellent patient response rates and a clean safety profile. The market’s response was initially muted but it has started to warm to the importance of this news, with Prothena’s share price rising by over 50% by month end. In our view, this new data significantly derisks the registration trial for the drug, which is due to read out towards the end of 2017 or early 2018. We met management during the month for a full update on the company’s pipeline development progress. We remain convinced that the current share price is profoundly undervaluing Prothena’s long-term potential, not just in NEOD001, but also in the Parkinson’s disease therapy that it is developing in partnership with Roche and in other earlier-stage but very promising drug development candidates.

There was also highly encouraging clinical data from 4D Pharma which reported a positive response from its Blautix treatment for irritable bowel syndrome in its first in-man trial. This is a very early-stage trial but the company has enough confidence in the results to advance the drug to the next stage of its clinical development. 4D Pharma is leading the way in the brand new field of live biotherapeutics, which use naturally-occurring bacteria in the human gut to potentially treat an extraordinarily diverse range of conditions, from Crohn’s disease through to autism spectrum disorder. In contrast to Prothena, however, 4D Pharma’s share price inexplicably declined during the month. Nevertheless, we continue to be very positive on the company’s long-term prospects.

Turning to portfolio activity, early in the month, with the market still befuddled by Brexit, we took advantage of distressed share prices to add to the positions in companies such as Legal & General, Provident Financial, Babcock, Capita and BCA Marketplace. Each of these businesses saw a healthy rise in its share price as the month progressed.

A new addition to the portfolio is Metalysis, which has been an unquoted position in the Patient Capital Trust since February and is making excellent operational progress. The company’s technology could be a game-changer for the metal industry with the potential to produce high quality titanium but with 50% of the energy usage of traditional processes.

The above additions were funded by further trimming the positions in Reynolds American and Roche. We also disposed of the position in BAE Systems. In similar circumstances to the recent decision to sell BT, not a lot has changed at BAE. Like BT, it has a substantial pension deficit which is something of a concern in this environment of ultra-low interest rates. Nevertheless, its yield remains an attraction but with only modest growth in the dividend expected over the next few years, it is no longer as appealing as other businesses in which we have increasing confidence in a more compellingly attractive total return.

In very simple terms, our total return expectation for a stock equals its dividend yield plus the anticipated rate of dividend growth (a change in valuation of that stock can either enhance or erode this return in any given period but, all else being equal, this is a very straightforward way of looking at prospective returns). If we take consensus data from Bloomberg as an example of this, at the time of writing we can see that BAE Systems is expected to deliver a yield of 4.1% in its current financial year. The prospective dividend growth over the next three years is forecast to be 2.3%, suggesting that, all else being equal, investors can expect a return of 6.4% per annum from BAE Systems in the coming years.

Now, all else never is equal of course, and we could argue for hours about whether or not that is a realistic growth expectation. Our expectation is that BAE Systems may well do slightly better than that in terms of dividend growth going forward but, even so, there are other investment opportunities out there which offer us significantly more attractive prospective returns.

One example is Provident Financial, a share which has featured in the portfolio since launch and one which we have been buying progressively ever since. We know the business well, we rate its management team highly and we have been consistently impressed with their ability to manage and deliver to investors’ expectations. The starting yield is 4.6% and that dividend is expected to grow by 15.9% per annum over the next three years. This suggests a prospective return of 20.5% per annum and provides a clear indication as to why we have been keen to build this position within the portfolio.

Provident Financial isn’t the only example – the vast majority of the portfolio’s assets are invested in stocks with attractive dividends and good sustainable dividend growth prospects. It is this, alongside the long-term upside that exists in smaller positions in earlier-stage businesses as they progress towards commercialisation, which gives us tremendous confidence in the portfolio’s ability to deliver high single-digit annualised returns to investors over the long-term.

LF Woodford Equity Income Fund
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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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