Equity Income  

Do Woodford’s struggles reflect a change in approach?

Rory Maguire

Rory Maguire

Perhaps the most common question we are asked today is ‘has Neil Woodford lost his touch?’ Here, we explain our response to clients through the lens of the Woodford Equity Income fund. 

Mr Woodford is obviously an active investor and this suggests that he believes he is above average. Simplistically, this can be read to mean that he charges an active fee because he expects to deliver a superior return to the FTSE All-Share index, over the long term. 

So how does he aim to add excess value? There are three main ways for any stockpicker to add value. The first is stock selection: having a positive hit rate in selecting more winners than losers, where a winner is a company whose share price beats the index performance over the holding period. 

Second is capital allocation: in theory a manager could be poor at stock selection, but allocate more capital to winners than losers. The third is to do with the skew of the returns: stock-selection success rates may be poor for private equity and small- or micro-cap managers – since they may buy more losers than winners – but winners can be so disproportionately large that it creates a considerably positive asymmetry in performance.

It appears that all three apply to Mr Woodford. This means that his past ability to allocate capital needs to evaluated, because the risk of an error of commission is far higher than for a manager whose top 10 is 20 per cent of the fund – Mr Woodford’s accounts for 40 to 50 per cent. 

He also backs small and unlisted companies where payoffs can be far more important than capital allocation. This effect can be particularly important for the manager, too, as he has almost 30 per cent of his fund across small caps, FTSE Aim companies and unlisted holdings. 

Within this context, and despite recent stock-specific issues, the team has historically shown skill in the requisite areas of added value over a long period. 

Mr Woodford and his strategy have been consistent over the long term, but he is now running his own company. Business considerations, the structure and staffing have evolved since Invesco, and new offerings such as the Patient Capital Trust (PCT) have been launched. There is no doubt that PCT is a large demand on his time, and requires far more hands-on analysis given the lack of sell-side coverage of private companies.

Also in need of consideration is client alignment, because if clients exit as fast as they joined, this could create liquidity issues with the smaller companies and unlisted tail. And while Mr Woodford may be ‘losing more sleep’ now that he runs his own business, this also needs to be factored in to establish whether the past is a good reflection of the current environment. 

Early signs suggests that his clients are long term and are unlikely to exit quickly. Equally, although Mr Woodford has different demands on his time now that he runs his own business and some different strategies, there is also a positive side to being an owner manager. While the view may be different on other strategies, it appears that there is a reliable continuity with respect to the Woodford Equity Income vehicle, particularly when compared with its predecessor fund at Invesco.