WOODFORD EQUITY INCOME FUND

Clients will no doubt have seen some of the extensive press comments on the recent dealing restrictions placed on this fund by the Fund Manager. This Clarion commentary on the events leading up to the dealing suspension might be of interest and provide reassurance to our clients.

Clarion considered investing in the Woodford Equity Income Fund at our regular Investment Committee meetings on several occasions but on each of those occasions we made an informed decision not to hold it based on our in-depth analysis. This decision was at odds with many of our competitors who held the fund because of the hitherto previous unblemished and impressive record of the Fund Manager, Neil Woodford.

CLARION PORTFOLIO FUNDS AND MODEL PORTFOLIOS HAVE NO EXPOSURE TO THE ABOVE FUND OR ANY OTHER FUNDS IN THE WOODFORD FUND RANGE.

THE WOODFORD STORY.

When Neil Woodford left the fund management giant Invesco Perpetual in October 2013 to set up his own company, he was without doubt Britain’s most-garlanded asset manager.

At the time of his departure, he had £33bn under management, more than any other fund manager. That reflected the faith that more than one million savers had put in him over the previous quarter century: the Invesco Perpetual High Income Fund, which he had run since 1988, had generated a return of 2,213% while the similar Income Fund had returned 1,839%.

That was way in excess of any industry benchmarks or comparable stock indices over the period.

The key to that performance was Mr Woodford’s investment style. This was a combination of buying and holding big “defensive” stocks in sectors like pharmaceuticals and tobacco – solid, reliable sectors that delivered a regular and predictable stream of dividends over the years.

He took big positions in such companies, too, with drugs majors Glaxosmithkline and AstraZeneca accounting for more than 17% of his two flagship funds when he left Invesco Perpetual. Among his other core holdings were Roche, the Swiss pharmaceuticals giant and the tobacco manufacturers British American Tobacco, Imperial Tobacco (now called Imperial Brands) and Reynolds American (now part of BAT).

This earned him criticism during the dot-com boom in the late 1990s but the bets paid off when, after the bubble burst in March 2000, investors rediscovered their appetite for reliable sectors like tobacco.

Similarly, during the build-up to the financial crisis, Mr Woodford stayed away from bank stocks on the ground that these businesses were too opaque to understand properly.

It earned him criticism before the crisis but proved a good call after the collapse of Lehmans in September 2008.

When Mr Woodford took a shine to a business, he bet on it big: his two funds at Invesco Perpetual owned 29.6% of the power generator Drax, 13.4% of BAE Systems and 9.9% of BT.

Yet he was also not averse to making more unconventional investments, backing a string of unquoted businesses in the early stages of their development, particularly in the life sciences sector.

Nor was he afraid to make big calls with his shareholdings. He backed AstraZeneca’s management when it resisted an unwanted takeover approach from US rival Pfizer, which proved to be a good decision, while his opposition to BAE’s proposed merger in 2012 with EADS, the owner of Airbus, helped kill the deal.

On setting up his new firm, Woodford Investment Management, in May 2014, Mr Woodford promised more of the same, telling the Daily Telegraph: “I’ll be here for decades to come. My best years as a fund manager are still in front of me. I learned a lot from my successes and failures. I’m a better fund manager now than I was 26 years ago.”

He promised that his fund management strategy would be the same as at Invesco Perpetual, identifying companies capable of continuing to deliver dividend increases on a sustained basis, as well as an element of growth.

SO WHAT WENT WRONG?

Perhaps one early-warning signal was his admission, at an event to promote the launch, that he had bought a banking stock – HSBC – for the first time since 2003.

Yet, to begin with, the Woodford Income Fund – which attracted £1.6bn at launch and, within months, drew in a further £1bn – appeared pretty similar to his old fund at Invesco Perpetual.

Its biggest shareholdings were AstraZeneca, Glaxosmithkline, Imperial Tobacco and BAT. Other UK stock market stalwarts such as Rolls-Royce and Capita were also core holdings.

A number of these bets, unfortunately, soured.

GSK’s share price is more or less where it was in May 2014 and has spent much of the intervening period below that. BAT and Imperial, despite their share prices rising during the first few years after Mr Woodford set up on its own, now trade at levels below where they were in May 2014.

Rolls-Royce, meanwhile, was rocked by a Serious Fraud Office investigation and it has spent most of the last five years trading below its May 2014 level.

Worse still is that there have also been a number of individual bets in non-blue chip stocks that have blown up in spectacular fashion.

They included taking a 29% stake in Utilitywise, Britain’s biggest energy broker, which collapsed into administration in February this year.

Then there was Purplebricks, the hybrid estate agent, of which Mr Woodford had been a supporter before it even floated on the stock market. Its shares fell by 64% last year, amid a softening housing market and increasing doubts over its business model, leaving Mr Woodford, who had accumulated a 29% stake in the business, nursing heavy losses.

Other flops included Provident Financial, the doorstep lender, in which Mr Woodford is the biggest shareholder with a 24.6% stake. Its shares have fallen by 71% during the last five years.

Capita, the outsourcing group, was another big shareholding until Mr Woodford bailed out at the end of last year. Its shares fell by 82% in the four years from May 2014.

Another disaster was Allied Minds, an intellectual property firm, in which Mr Woodford has a 27.4% shareholding.

Its shares have lost three-quarters of their value since the co-founder unexpectedly quit in April 2017.

Then there was Prothena, a struggling Irish biotech firm, in which Mr Woodford has a 29.9% stake. Its shares have more than halved since the beginning of May 2014. Circassia Pharmaceuticals, in which Mr Woodford has a 28% stake, was another flop.

And not forgetting Kier Group, the struggling construction services company, in which Mr Woodford has a 20% shareholding. Its shares fell by 40% just before dealing in the Woodford Equity Income Fund was suspended.

One or two of these setbacks would have hurt any fund manager. What really did the damage was the growing publicity around this poor performance and, in particular, some adverse coverage in the influential personal finance pages of the Sunday Times and the Mail on Sunday.

From a peak of £10.2bn in May 2017, the Woodford Equity Income Fund had shrivelled to a still-substantial £4.8bn by March this year as investors pulled out their money.

In order to give those investors their money back, Mr Woodford had to sell down the fund’s shareholdings in its bigger, more liquid stocks, such as Imperial.

More of the companies in which Mr Woodford was heavily invested then found themselves the targets of ‘short-sellers’, investors who speculate on a share price falling, as they tried to predict what stocks he would have to sell next to meet redemption requests.

By March this year, Mr Woodford – who in his days at Invesco Perpetual seldom, if ever, spoke to the press – was trying to fight back. He told the Financial Times that investors were being pushed into “appallingly bad decisions” by “misinformation and lazy commentary”.

He added: “There is a mountain of fake information and fake analysis in the marketplace which, in the end, does impact investors decisions detrimentally.

When you passionately believe in what you’re doing, as I do, when clients are saying ‘nah, we want our money back now because we’d much rather be investing in these things that have gone up’, that, for me, is a frustration. I think they’re making a poor investment decision.”

He admitted that the firm could go out of business in “about two and a half years” if he failed to raise performance and stem the investor withdrawals.

By now, though, he had another headache.

The forced sales of big liquid quoted stocks meant that the proportion of the fund invested in unquoted companies – stakes in which can be less easily offloaded – rose as a consequence and breached the 10% limit set by regulators at the Financial Conduct Authority.

By March this year, the online financial information provider Citywire was reporting that 17.9% of the Woodford Equity Income Fund’s assets were tied up in illiquid, unquoted businesses.

Mr Woodford got around this by swapping some of those shareholdings from the fund and into the quoted Woodford Patient Capital investment trust – with the fund receiving shares in the trust in exchange.

Stakes in four more companies, including Benevolent AI, one of the fund’s biggest remaining investments, were hurriedly listed on Guernsey’s International Stock Exchange.

Yet the redemptions kept on coming and, by last month, the Woodford Equity Income Fund was down to £3.77bn.

The last straw was a reported request from Kent County Council for £250m.

Mr Woodford was forced to slam the gate shut on his remaining investors. A glance at the portfolio reveals why he had no choice.

Of the fund’s top 10 biggest shareholdings, only two – the house-builders Barratt Developments and Taylor Wimpey – are in the FTSE-100 and can be sold down easily.

He will find it less easy to offload, for example, his 8.99% shareholding in the litigation funding group Burford Capital, whose shares recently fell by more than 4%, or his 23.83% shareholding in Theravance Biopharma.

So it is hard to see how the business can recover from this and easy to see why some in the City have been talking about Woodford Investment Management being in a “death spiral”.

Backers of the Woodford Funds such as Hargreaves Lansdown and St James’s Place will need to weigh the impact to their reputations of sticking with Mr Woodford. Recent stock market manoeuvres by this onetime champion of transparency have discomforted some fellow fund managers.

CLARION CLIENTS WILL BE PLEASED AND COMFORTED TO KNOW THAT THE WOODFORD EQUITY INCOME FUND WAS PASSED OVER BY THE CLARION INVESTMENT COMMITTEE ON A NUMBER OF OCCASIONS. AS MENTIONED ABOVE, NONE OF THE CLARION FUNDS OR THE MODEL PORTFOLIOS HAVE ANY EXPOSURE TO ANY OF THE WOODFORD FUNDS.