Russell Taylor: Woodford’s downfall is a painful reminder to investors

Some middlemen make their money by sating the appetites of those who already have too large a proportion of their assets with flavour-of-the-month managers. They, and others, quickly swarmed over Mr Woodford.

St James’s Place, Hargreaves Lansdown, this pension fund adviser and that county council pension manager were among those who shovelled their millions his way. Some did not bother to properly check why Mr Woodford had been successful, instead contenting themselves with salivating over their expectations.

And Mr Woodford had been good as a stock picker, particularly among smaller companies overlooked by the big boys, or new or out-of-favour stocks requiring courage, imagination, and patience. 

This ability to see the income potential, when few others can, is what makes a good investment manager, since it is only an above average and growing income that justifies rising capital values. This is the only magic behind successful investing.

Illiquidity issues

The irony of Mr Woodford’s failure is that the denouement took place at roughly the same time as the Association of Investment Companies was adding to and rejigging its investment sectors. Its goal was to ensure these groupings remain relevant given the proliferation of market indices and new asset classes seen over recent years. One of the fastest-growing sectors of the AIC universe is that which houses those investors keen to hold ‘illiquid’ investments, such as property or private equity, for which a closed-ended investment trust is ideal.

Such a structure would have saved Mr Woodford, and bought him the time for his strategy to work. But he was brought up in the open-ended world, where the emphasis is less on performance than marketing, and often more to do with gaining assets under management than satisfying clients. Setting up his own company allowed the manager to profit from his early success more than would have been the case at Invesco Perpetual. But he would not have been allowed to invest as he did if he were still working at that company as part of a hierarchical structure.

Classification changes

For full details of the 13 new investment trust categories, as well as 15 renamed groupings and 21 unchanged sectors, the best resource is AIC’s own website. Some of the categories might suggest Woodford-type risks lie within.

Property lending can certainly be profitable, but any quick glance at the history of banking makes clear quite how dangerous this activity is. At some points loans are hard to get, and margins are thin, but at other times the opposite is true. And going from feast to famine can unsettle lenders, and suddenly they find themselves having both lent and borrowed too much – and loans, even assuming they are good, can be hard to liquidate quickly.

So investing in the new property categories needs care and caution. Bonds and loans are all very well, but the risks are there, even if hidden, because the underlying asset is often property. And property can be as changeable as a companies’ fortunes. The current mayhem on Britain’s high streets is proof of that.

Investment company DNA is buying in bonds and shares. It is also political diversification for the sake of security, and the creation and delivery of an annual income. It is not luck that means some trusts have increased their payouts every year for the past 50 years but canny investing, like Mr Woodford himself but within a disciplined framework.

And shares give a fundamental benefit compared with any other security. They are dynamic, their profits fall or rise depending on the state of the economy and the decisions of their managers. While the average life of a company is eight to 10 years or so, the successful can last a century or more. And each year the tax system allows them to store away profits, as reserves, increasing their wealth and the value of their shares. It is this added yet hidden wealth that enables compound interest, as described in last month’s article, to work its magic.

The era of Asia

The good news is that the increased classification of investment sectors shows that trusts have fully adjusted to the Asian century. There are now three Asia Pacific categories devoted to income, smaller companies, and generalist strategies – as well as plenty of individual country and technology stocks. This is our future, and a recent Baillie Gifford article on China, its attitude to patents and intellectual property, will be an eye opener for most of us.

Currently, investors are frightening themselves with worries about a coming end to this 10-year-old bull market, as well as out-of-control debt, and President Trump’s new toy – tariff threats. As it stands the anti-Brexit portfolio is holding up reasonably well, as Table 1 shows.

Table 1: Anti-Brexit portfolio update

Note: *Witan underwent a 5:1 share split in May 2019. All values have been adjusted accordingly. 

Source: AIC/Morningstar. Copyright: Money Management

For the moment, the president’s actions are hurting his own citizens at least as much as his trading partners, but this may not always be the case. The dynamics of a relationship between an ageing superpower and an emerging one such as China are unstable, even at times when both understand each other. And this they do not do at the moment, as the Baillie Gifford article makes all too clear.

But what both the existence of investment companies and Mr Woodford’s downfall make clear is that successful investment requires two things. One is time and the other is money. 

Long-term investment is about ‘free money’ – something outside of day-to-day living, and the stuff that can be lost without family destruction. However tempting it may be to use other monies, only free money has the patience to wait for time and income to prove themselves. And the new investment trust sectors enable all of us to allow our imaginations to soar, while recognising that the DNA of investment companies will give our money the discipline that Mr Woodford so sadly lacked.