In October 2016, the Jupiter Merlin team organised a conference in London to talk about successful investors.
Fund managers Neil Woodford and Terry Smith were invited as panellists to discuss their approach to stock picking, their sell discipline and their influences. Warren Buffett and Benjamin Graham were among the names quoted by both as influencers, as we might expect.
However, their debate highlighted significant differences in the application of their principles. Others have discerned the same differences – the Jupiter Merlin team sold their stakes in the Woodford Income Fund in 2017, while the Fundsmith Equity Fund has remained a key component of their growth portfolio.
Both Mr Smith and Mr Woodford have had extensive investment careers and have experienced many different market regimes since their careers began in the 1980s. Also, both have been at the forefront of industry transformation.
- Neil Woodford and Terry Smith have many things in common, such as being contrarian investors
- They have only held one stock in common, despite sharing a preference for cash flow analysis over earnings
- Both generate alpha at different time periods to the rest of the market
Following the successful launch of Mr Smith’s investment trust, the Smithson Investment Trust, it is perhaps useful to compare the two fund managers. In 2010, Mr Smith left brokerage company Tullett Prebon to establish FundSmith; while Mr Woodford left asset manager Invesco Perpetual to launch Woodford Investment Management in 2014.
A new model
Mr Smith and Mr Woodford share similar views on how to build a modern investment firm and both have launched their own boutiques, so they can stay focused on a single investment expertise. They are strongly opposed to large asset management companies, which attempt to diversify their revenues by asset classes, that is, diluting the expertise across too many desks with little interaction between them.
The organisation of their companies is concentrated around a single investment team, which is made up of a small group of analysts and portfolio managers – other functions could be easily outsourced. They also want to reduce the high fees associated with the active management industry. This is mainly achieved by cutting the costs of dealings and frequent trading.
Mr Smith and Mr Woodford both believe in investing in a company for the long-term, which means the portfolio turnover can be reduced. Both consider the market to be inefficient as its participants are very much influenced by short-term changes in earnings and valuations. The fundamental value of a company can only be realised over a business cycle, irrespective of the short-term market fluctuations and economic conditions.
Mr Smith and Mr Woodford often describe themselves as “contrarian investors” because of their capacity to maintain a long-term holding in a company. In the event a profit warning is issued by a company, both fund managers are willing to maintain their faith in the prospects of a company if its potential intrinsic value remains intact.
Cash is king
Their shared desire to invest for the long-term is also the reason why they have the same preference for free cash flow analysis, and why they pay so little attention to earnings, which could be easily manipulated. It also explains why both managers adopt an absolute return approach to equity investment.