Has Neil Woodford lost his touch?

6 mins. to read
Has Neil Woodford lost his touch?

Neil Woodford is one of the country’s best known and most successful fund managers, but in the last few weeks a number of his largest holdings have suffered dramatic price falls. The most spectacular of these was the doorstep lender, Provident Financial (LON:PFG), which Simon Cawkwell had highlighted as a short at 2,100p in his Evil Diaries, describing it as ‘an absolute sitter’.

Three weeks after he posted his comments the company issued a profits warning and announced that it had replaced the MD of its consumer credit division with immediate effect. The performance was so bad that the dividend was removed and the chief executive resigned, all of which sent the shares an amazing 66% lower on the day.

Anyone who had listened to Simon would have made a massive profit, whereas investors in Woodford’s fund would have found themselves on the wrong side of the trade. At the end of July, Provident Financial was the fourth largest holding in the £9.8bn CF Woodford Equity Income fund with the 4% weighting representing a 19% stake in the company.

The fund has also taken a number of other significant hits. A few weeks ago Woodford publicly announced that he had sold his entire holding in the pharmaceutical giant GlaxoSmithKline (LON:GSK) because of the drugs maker’s refusal to break-up and his concern about the sustainability of the dividend.

Unfortunately he decided to back the rival drugs maker AstraZeneca (LON:AZN) and retained it as his largest holding at 8% of the fund. A few days later on July 27th the company announced news of a disappointing clinical trial for a key cancer treatment that knocked its shares down 16% in the day. This was the blue chip’s worst ever day of trading.

Pharmaceutical companies have long played a major role in Woodford’s portfolios as have certain Tobacco stocks, but these have also suffered recent falls. On July 28th the US Food and Drugs Administration announced that it was planning to lower nicotine levels in cigarettes to non-addictive levels. This knocked the shares in Imperial Brands (LON:IMB) – the third largest holding in the CF Woodford Equity Income fund – down by 9% on the day.

Failures amongst his smaller, more illiquid holdings

Woodford tends to take bigger stakes in the companies that he likes than you typically see with many other funds. This can really pay off when he gets the stock selection decisions right, but if he gets them wrong it can have a significant detrimental effect on the overall performance.

It is one thing to do this with the large, liquid blue chip stocks, but he is also willing to do it with smaller, illiquid, higher growth companies. He has always invested in these sorts of holdings as a way of boosting the total return and historically it has tended to pay off, although there is no denying the risk.

At the end of July his Equity Income fund had 136 separate holdings, with more than 100 of them each accounting for a fraction of a percent. These included lots of tiny Health Care and Financial stocks.

Small stocks like these inevitably involve a higher degree of risk and some are almost certain to come unstuck. This was the case with the £307 million technology company, Allied Minds (LON:ALM), where Woodford is the largest shareholder with a 27.8% stake. In April the company announced that it had cut the funding for seven of its subsidiaries with the result that the shares are down about 70% in the last six months.

The problem with taking large stakes in small companies is that Woodford is pretty much stuck unless the stock succeeds to the extent that he can achieve a successful exit. It is almost a Private Equity type situation.

Another example is the monitoring device maker Sphere Medical Holding (LON:SPHR), which has seen its share price collapse after it said that it could run out of cash in the near future.

At the other end of the scale is the hybrid estate agent PurpleBricks (LON:PURP), which has seen its share price rise by around 300% in the last year. The company is now worth £1.17 billion and is the ninth largest holding in the fund with a weighting of 2.44% at the end of July.

The problem with taking large stakes in small companies is that Woodford is pretty much stuck unless the stock succeeds to the extent that he can achieve a successful exit. It is almost a Private Equity type situation.

This is a point that Simon recently highlighted in another of his Evil Diaries. With PurpleBricks for example, Woodford Investment Management owns 27% of the company and is by far the largest shareholder. It could be real problem if investors lose confidence in the stock because it would be impossible to exit without completely trashing the share price.

Tried and tested

Woodford made his reputation at Invesco Perpetual where he ran their Income fund from October 1990 until May 2014. Analysis by Killik & Co reveals that during this period he achieved an annualised compound return of 14.3%. This was around 5% per annum better than the FTSE All-Share index and the average UK Equity Income fund. It was also less volatile.

The success enabled him to set up his own investment management company with the first of his funds, CF Woodford Equity Income, being launched in June 2014. This has a similar mandate to the fund that he ran at Invesco Perpetual and it had a successful start as it topped the UK Equity Income sector over its first year.

It has been a very different story over the last 12 months with the fund being the worst of the 84 in its peer group and the only one to have lost money. Despite this, over the period since launch in June 2014, it has beaten both the sector average and the FTSE All-Share by almost 10%.

There is probably a touch of Schadenfreude in all this and Woodford is especially easy to pick on because he is one of the few managers to publish his entire list of fund holdings. It is also important to bear in mind how much value he has added over the years by backing his judgement.

Another point to note is that he has addressed the recent sharp share price falls in detail in his latest fund update, which he sums up by saying: “We remain convinced of the attractions of all the companies we mention earlier and believe that their share prices are sitting way below their fundamental value.”

He concludes the note by saying: “We are incredibly confident about the long-term outlook for the fund from here. The fund’s strategy…. remains intact and we believe will deliver very attractive returns as it becomes increasingly clear that the underlying performance of the UK economy is both robust and improving.”

It is hard to argue against Woodford’s long-term track record and I suspect that the weak recent performance will be followed by a period of strong returns relative to his peers. I would just make two final observations:

The first is that CF Woodford Equity Income is not a normal UK Equity income fund and has a long tail of large stakes in relatively small stocks. These are illiquid and have the potential to have a big impact – for better or for worse – on the overall return.

The second is that the large share price falls following the various negative announcements, that Woodford thinks are out of proportion to the fundamentals, suggests to me that investors are nervous and don’t need much of an excuse to sell. I think it is further evidence that we could easily see a significant market correction.

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