The rating of the Woodford Equity Income fund has been cut to neutral from the previous bronze. The highest possible rating is gold, and the only rating lower than neutral is negative.
The Woodford Equity Income fund has shrunk in size from £10.1bn to £4.4bn between the 2016 Brexit referendum and now as investors have shunned the manager’s exposure to the UK domestic economy and to unquoted early stage companies.
Mr Woodford updated investors at the start of May that he will reduce the fund’s direct exposure to unquoted shares and instead gather the exposure via an investment in the Woodford Patient Capital investment trust, which he also runs.
Patient Capital invests in unquoted shares, but because it is an investment trust listed on the London Stock Exchange there should always be liquidity for investors.
Mr Woodford’s confidence in the relative prospects of the UK economy compared with the rest of the world has largely been vindicated, with the UK being one of the fastest growing economies in the developed world.
But that economic performance hasn’t altered the valuations at which UK domestic shares trade relative to overseas earners in the UK.
The fund has lost 15 per cent over the past year, compared with a loss of 4 per cent for the average fund in the IA UK All Companies sector in the same time period.
Peter Brunt, associate director for equity strategies manager research at Morningstar, said: "Persistent redemptions, underperformance, and stock-specific issues, combined with the manager's relentless willingness to push the portfolio to its liquidity limit, have resulted in portfolio positioning that we consider extreme.
"Contrarian investing comes with a degree of risk, and issues can be expected from time to time. However, the nature of some of the stock specific problems and their respective position sizes, combined with the extreme portfolio positioning, give us cause for concern.
"While we acknowledge that there may be unrealised value in the portfolio, the aforementioned have led to a lower level of conviction in the strategy's ability to consistently outperform over the long term.
"We are therefore lowering the strategy's Morningstar analyst rating to neutral from bronze."
Brian Dennehy, an adviser who runs Fundexpert.co.uk, said he hasn’t recommended the fund to clients from day one, because he believes the exposure to mid and smaller company shares means the fund is being run in a different way to the style that Mr Woodford was using when he developed his reputation.
In his most recent update to shareholders, Mr Woodford said his underperformance in recent years was the result of the value style of investing he deploys being out of favour with the market, but that every time this has happened historically the value style has recovered.
A representative of the company added that Mr Woodford has always had significant exposure to mid and small cap companies.
Dzmitry Lipski, investment analyst at Interactive Investor, said contrarian investors should be mindful that the fund today is very different to the fund it was three years ago.
He said: "TD Direct (now part of interactive investor) removed the fund from its recommended list three years ago, on my recommendation.
"At the time, I was uncomfortable with the structure of this fund, not least due to its unquoted holdings and biotech exposure - our analysis showed a strong correlation between the Woodford Equity Income fund and Woodford Patient Capital Trust.
"The fund today is very different to where it was three years ago.
"The barn has had a thorough sweep, with unquoted stocks transferred to Patient Capital Trust, with a closed-ended structure much better suited to illiquid assets. This should help reduce risks and provide more clarity to investors."
david.thorpe@ft.com
