The house of Woodford

I invest in funds and therefore I invest my hopes in fund managers and their investment performance. I am therefore glad to not be invested with the well-known fund manager Neil Woodford as his well won investment reputation has turned to ruin.

Despite being a fund investor for around the same time as Neil Woodford has been a manager of funds, I did not invest in his funds for over twenty years as he built his reputation. He managed UK income and high-income unit trusts for Invesco Perpetual from around 1988 until 2014. He exceeded the index by avoiding the worst of both the dot com bust of 2001 and the financial crisis of 2008. Instead of investing in the dot com firms in 2001 and the banks in 2008 he favored tobacco companies. After he took over the management of a UK equity income investment trust for the first time, in 2008, I saw that as a good opportunity to invest. My investment in Edinburgh IT (EDIN) coincided with his management for the five years ended on 31 January 2014. During that time the share price total return of £217.80 on an investment of £100.00, exceeded that of my benchmark the FTSE All Share Total Return which returned £200.90. It was, however, below the sector average of £239.20, and below all my other holdings in the sector. At the time I was satisfied with the performance.

His leaving Invesco Perpetual after twenty-six years to set up his own business was a big news story. I followed this with interest but was not too keen to invest in his new venture. This was for several reasons. I aim to buy and hold for the long term. I had a positive view on his successor at Invesco Perpetual, Mark Barnett, who now took on Edinburgh IT. I don’t favor new issue investments and prefer those with a long history. I don’t like to follow hype or over-promotion. I prefer investment trusts to unit trusts. Woodford’s first new fund was the Woodford Equity Income unit trust. I didn’t invest.

His second new fund was the Woodford Patient Capital IT. Although it was an investment trust all my other reservations applied. Also, this fund aimed to invest in new start up and unquoted ventures which was not something I was looking for. I didn’t invest. His third fund was the Woodford Income Focus unit trust. All my original reservations also applied to this one. I didn’t invest.

Initially in it’s first year Woodford Equity Income performed well. Woodford Patient Capital raised more money than it was expecting and, at first, the share price rose to be higher than the asset value. Subsequently, however, some problems surfaced. The Woodford Equity Income unit trust was investing not just in FTSE 100 companies paying above average dividends as expected, but it was also investing in unquoted companies that didn’t pay dividends. This has meant that it has not fully paid the dividends promised at outset. More importantly as a unit trust it was unsuited to holding unquoted companies that it could not sell to pay-out to investors selling out. This became a problem as performance deteriorated and investors sold and the fund came to be increasingly populated by unquoted holdings. Various controversial things were done in order to attempt to address this issue as the unit trust was supposedly limited in the percentage of illiquid assets it could hold. Eventually a significant shareholder requested a large sale and the unit trust was forced to stop all sales and purchases. Without it having re-opened it has now been announced that it will be closed and liquidated and the investors will be paid back what can be realised. The Woodford Patient Capital IT is looking for a new manager and may also close down. The Income Focus unit trust has now also had to stop all sales and purchases and seems likely to close.

My impression of these events suggests to me that Neil Woodford didn’t invest as he was expected to, and maybe not as he promised too. This was no usual UK equity income fund. He invested in unquoted companies which was not the area in which he had built his previous reputation. Such illiquid holdings were entirely unsuited to a unit trust, and especially one which had been heavily promoted, or hyped, to small investors. He persevered with this approach rather than bail out earlier and take a loss on these holdings. The regulators appear to have failed to manage the unfolding situation. He would have done better to have had one genuine income fund and one separate unquoted fund rather than create a hybrid fund that has dragged all three of his funds down.

This story reinforces to me the importance of portfolio management. I aim to have no more than around 10% in any one fund so as to limit manager risk. I hold less in more specialist funds. I also diversify by fund house, by fund sector, by geography and by asset type. I still hold a relatively small number of funds but I aim to watch them carefully so as to avoid the next such problem.