What Should Investors in Woodford's Fund Do?

Morningstar Investment Management's Cyrique Bourbon examines the recent poor performance of UK equity income fund manager Neil Woodford

Emma Wall 12 February, 2018 | 7:48AM



Emma Wall: Hello, and welcome to the Morningstar series, "Ask the Expert." I'm Emma Wall and I'm joined today by Morningstar Investment Management's Cyrique Bourbon to talk about Neil Woodford.

Hi, Cyrique.

Cyrique Bourbon: Hello, Emma.

Wall: So, Neil Woodford has been in the press a lot over the last 12 months but not for positive reasons. Why has Neil been making headlines?

Bourbon: Obviously, the headlines have been related to his performance and the fact that a couple of his holdings, sort of, the high-profile holdings he has had, have been in the press with negative news surrounding their businesses and their share price falls.

Wall: And are these the type of companies that Neil normally holds? Because his performance over the last 10 years has been pretty impressive. This seems out of out of character?

Bourbon: So, I think, there's two things. I mean, one, Neil has tremendous track record. He has been investing for about 30 years. And you have to think that he has invested in generally undervalued companies for a very long time that have been different at different points in time. At the moment, he has got about a third of his portfolio in companies most domestic U.K. economy and obviously, these are under pressure in general.

But it has happened in the past that he has had exposure to actually some similar names that he has in the portfolio now such as when he had some exposure to some of the Babcock, some of the Topps Tiles, et cetera, in the late '90s, early 2000s and also, in the early '90s, '91, '92, '93, in the midst of the recession. So, he has had similar positions to certain names like this on the domestic side before.

Second aspect is obviously mistakes. And obviously, some of the high-profile stocks that have been reported in the press have been, in some cases, mistakes and Neil has acknowledged some of these mistakes.

The bottom thing to remind ourselves is, any fund manager will make mistakes in their portfolios when they select stocks. Generally, we say, the best managers will get about 60% of their stocks right versus 40% wrong. When you think about 40%, in actual number of stocks, that's actually quite a big number for the best managers.

At the moment, Neil actually is running with a hit rate that's more about 20% right versus about 80% wrong, wrong being in share price terms in the short term. He has a long-term view and we have faith that he is sticking to his process obviously amidst a bit of challenging environment for the U.S. economy for some of the stocks, for some of the businesses, but he looks at the valuation of these businesses compared to what he believes should be a fair price given the cash flows and the way the businesses are operating.

Wall: And that's an important point to make, isn't it? Because even the very best fund managers cannot be a 100% right on a 100% of their portfolio all of the time. And Neil, in fact, was unpopular with his call on pharmaceuticals in the past. So, is the message just hold the fund for now and wait and see? Take the long-term view?

Bourbon: Very true. I think it's important to remember that the performance pattern of Neil's fund in the last 12 to 18 months is not dissimilar to what has happened to his fund before. He obviously underperformed significantly in the rebound in 2009-2010. He also lagged massively in 1999 until the beginning 2000 when the tech bubble burst.

So, he has had similar extent of underperformance. You look at the share price movements of some of the stocks, some of the stocks down 50%, 60%, 70%. This is not very dissimilar to some of the stocks he held, for instance, in tobacco. In 1999, some of the big tobacco stocks of today were down 40% to 60% in 1999, for instance.

Wall: So, what in your opinion, as the fellow shareholders, should investors in Woodford Equity Income do?

Bourbon: So, in my opinion, investors should stick to the fund. It's very often when performance is very challenging, when a fund manager is under pressure that you should stick to it as long as that fund manager you believe is doing similar things into his process. Obviously, his investment team is very much unchanged, his process is very much unchanged. One, he has taken a macro view before very different to the market; generally, has been proven right. And two, he sticks to some sectors, some companies that have been unloved where he has taken a different view from the market at the stock level. In my view, as long as he still does that, there is no issue holding his fund in the future.

Wall: And finally, it's worth making the point that we have seen a lot of volatility in markets over the last week and I expect that Neil will not be the only fund manager over the course of 2018 to have periods of underperformance. Is this the new norm?

Bourbon: This is the new norm. I think it's going to be fund-by-fund as well. So, a lot of funds that have done phenomenally well in the last five to six years have been riding some themes. For instance, you think about emerging markets or U.S. equity funds. If you've had exposure to internet-related names, tech names, you've done phenomenally well.

Some more value-oriented managers haven't had exposure to those big themes. Those might not last forever. That is a strong message that investors should remember. Things and themes do not last forever in a straight line. There is always a price for these and when the price is too expensive, it basically has to return to a more normal price. And on the other side of the coin, obviously, fund managers like Neil Woodford might actually start thriving when valuation disciplines start reverting in terms of investors' mindsets changing to more normal levels.

Wall: Cyrique, thank you very much.

Bourbon: Thanks for having me.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
LF Woodford Equity Income C Sterling Acc79.06 GBP-0.10

About Author

Emma Wall  is former Senior International Editor for Morningstar

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