Exclusive interview: Neil Woodford explains why he remains confident his bet on the UK domestic economy will pay off.
This is not the first time in his career Neil Woodford has faced a barrage of criticism after his performance has slipped down the fund league tables. Almost two decades ago, Woodford was widely condemned for not loading up on technology names. But the tech bubble then popped spectacularly and he was vindicated.
This time, in the age of social media, the scrutiny is more intense and much less polite, but Woodford is not a man to hide from his critics. On his personal blog last September, he apologised for his investment performance taking a turn for the worse.
In this exclusive interview for Money Observer, Woodford explains why the UK equities sector is wrongly viewed as a basket case and lifts the lid on his investment thinking on Brexit. He addresses the issue of performance and passionately defends his belief that he will ultimately be proved to have acted wisely in betting on the fortunes of businesses heavily exposed to the UK domestic economy.
Still backing Britain
He has a substantial weighting – around 60 per cent in his Woodford Equity Income fund – to domestic-facing businesses that have been cold-shouldered since the Brexit vote in June 2016. Indeed, billions of pounds have exited all kinds of UK funds over the past year; international investors in particular have been heavy sellers.
According to Woodford the perception is that the UK is a ‘basket case economy’ because of the steep slump in the pound that followed the Brexit vote. The weak pound stoked inflation, which in turn squeezed real incomes. This, he says, caused ‘investors to run away from the UK’, as a snap judgement was made that Brexit would be a disaster for the UK economy.
Woodford, however, disagrees with the doom mongers. He argues that there is a ‘mismatch between reality and perception’. In his opinion, the spike in inflation will prove to be temporary thanks to sterling’s recovery over the past year, and he predicts that it will cool towards 2 per cent from its current 3 per cent over the course of 2018.
‘There are a lot of things I would disagree with in terms of what is happening in financial markets, but what stands out as being completely and utterly wrong is the negative perception towards UK equities and the UK economy. Since the Brexit vote, the UK economy has outperformed the consensus, and I expect it to continue to do so in 2018. I think the view that growth will slow as the lagged effects of the Brexit vote finally come home to roost in the UK is totally wrong.’
Woodford points to a strong labour market, evidenced by record employment, and he says wage growth will improve during 2018 as inflation falls. He expects the government to spend more money in 2018, pointing out that government tax receipts have ben rising. ‘Add all that up and I think you have a more buoyant picture than the consensus would have you believe,’ he says. His views on the economy have been correct in the past. Following the financial crisis, he cautioned that growth would be anaemic for several years. This time around, however, his call on the economy seems particularly bold, because if he is wrong, the ‘cheap’ domestic stocks he is backing to bounce back are likely to remain out of favour.
Bargain basement prices
Woodford is convinced that a catalyst of some sort will change investors’ perceptions at some point. However, he acknowledges that predicting what the trigger will be and when it will occur is impossible. He describes domestic stocks as being in a ‘bear market’, as evidenced by a plethora of shares with single-digit price-to-earnings ratios. Shares that he says stand out for their ‘bargain basement’ prices include Lloyds Banking Group, Babcock International and the housebuilding sector.
He says: ‘Sooner or later there’s going to have to be an acknowledgement that the UK is not a basket case. Throughout the year there will be umpteen opportunities for the economy and the companies that operate in it to prove this overwhelmingly bearish consensus wrong.’ Once there’s a realisation that the UK economy is performing better than it’s being given credit for, domestic stocks will come in from the cold, he argues, with share prices adjusting to reflect the reality that the cash flows, profits and dividends of UK-exposed companies are better than their current valuations suggest.
Tilting the portfolio towards domestic stocks has so far come at a big cost: his fund shows a 5 per cent loss over the past two years, whereas the average Investment Association UK equity income fund gained 25 per cent over the period. Woodford describes his fund’s performance as ‘incredibly painful’, but he is sticking to his guns.
He says: ‘I have never been a momentum investor, which at the end of the day is what most fund managers do. They take that route because where I am now is about as uncomfortable as it can get professionally – it is a horrendous place to be. Most of the incentives from a remuneration point of view, the way we are measured and the tenure of our jobs all work against doing what I do as a fund manager, which is why few people do it.’
Failures among favourites
Woodford’s domestic bet is not the only reason his performance has been sluggish. A number of favoured holdings have turned sour, most notably Provident Financial, the doorstep lender, shares in which plummeted in value last summer after it issued its second profit warning in as many months. Woodford Equity Income’s size, at £7.2 billion, is also considered problematic in some quarters.
In response, Woodford argues: ‘Everybody is very influenced by what has just happened, both in the economy and in our industry. We have had a difficult period of performance, so I think people are worried about the portfolio: whether there are Provident Financials all over the place, whether I have lost it, whether the fund is too big. But I think we will prove people wrong on all of those counts.’
Other holdings have also been troublesome, most notably outsourcing firm Capita. At the end of January the share price tanked, following a profits downgrade and dividend suspension. Just weeks earlier, Woodford had increased his holding via Woodford Income Focus, his other, newer income fund.
The dilemma for investors is a question of timescale. For two years now, Woodford Equity Income has underwhelmed. If this situation continues for another year, his loyal followers’ patience will be further tested. Some multi-managers have already bailed out, but retail investors have largely kept the faith so far. However, the fund has shrunk from £8.2 to £7.2 billion since the start of 2018.
Woodford responds: ‘We say, judge us on our three-to five-year returns. That’s how I invest and how I expect to be judged. But I know the market has a much shorter-term horizon. People are very short-term performance-oriented. We said when we launched the fund that we expect to deliver high single-digit annualised returns over three to five years. Since launch [up 24.5 per cent], we are about where we said we would be, but it has not been smooth. We had a good start before the difficult period. I am very confident that we can deliver what we have advised our investors to expect. Indeed, I would hope to do better than that.’
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Will Woodfords boats rise with his tidal bets?
I just worry that Woodford is basing everything on a macroeconomic bets at the expense of stock picking.
I hope that his picks then rise if his macro focus is proven right but I really worry that he is not covering the ground well enough in knowing the businesses he's investing our money in. If not his funds won't rise even if he is right about a revaluation of UK stocks. I need more reassurance!