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Is Woodford biting off more than he can chew?
As Neil Woodford eyes more funds for his Patient Capital investment trust, we take an in-depth look at his record of 'early stage' investing.
by Daniel Grote on Jan 13, 2016 at 14:38
Shares in the trust have fallen further from their 100p issue price on the news, and they might argue the manager should first focus on delivering a positive return before raising even more funds.
As with the Fidelity trust, a large initial fundraising has been followed by plans to gather more money. For some critics, the parallels stretch further: while Bolton came unstuck when venturing beyond the UK stock market he had mastered in nearly three decades at the helm of the Fidelity Special Situations fund, could the same fate await Woodford?
Ewan Lovett-Turner, investment trust analyst at Numis Securities, alluded to this. ‘It is unusual to be raising additional capital when the shares are trading below the initial public offering (IPO) price and note that previous “blockbuster” investment trust IPOs have often failed to meet the inflated expectations of retail investors,’ he said.
‘Early stage’ scrutiny
With shares in Woodford Patient Capital now down 3.7% since its launch in April last year and the net asset value 6.3% lower, Woodford has also faced scrutiny of his ‘early stage’ investment credentials following allegations of financial impropriety against one of his holdings, Northwest Biotherapeutics (NWBO.O).
There’s no doubting Woodford’s enthusiasm for early stage investing. ‘The more that we have done in this space, the more we have become convinced that this is an incredible area for investment,’ he told Citywire. ‘The early-stage asset class is largely neglected and fundamentally undervalued.’
But one major backer of the manager prefers that he concentrate on the big blue-chip investing with which he made his name.
Woodford runs another fund for financial adviser group St James’s Place, their UK High Income fund, and has done since the turn of the century. In September 2014, St James’s Place decided to put a stop to Woodford’s investment in small company stocks, limiting the UK shares he could buy to companies in the FTSE 100 and FTSE 250.
It’s a decision at odds with the investment philosophy driving the man they have entrusted with more than £4 billion of their clients’ money. In his St James’s Place fund, Woodford has been selling his smaller company stocks, with the proportion of the fund in FTSE Small Cap, Alternative Investment Market (AIM) and unquoted shares at just 1.7% in November. That is set to reduce to 0.8%, as one of these holdings is expected to enter the FTSE 250 at the next rebalancing point.
St James’s Place said the decision to remove small caps, taken when the mandate followed Woodford from Invesco Perpetual to his new firm, was due to that sector of the market already being catered for by other funds it offers.
‘Any decision we make reflects the role our fund plays within our portfolio of managers,’ said Andrew Humphries, marketing and communications director at the group.
‘We have other UK equity income managers who focus on the small and mid-cap part of the market place and therefore we asked Neil to focus on the large and mid-cap space.’
Reputation for big calls
For all Woodford’s enthusiasm for early stage investing, he owes his stellar reputation within fund management to the big sector calls he made at the helm of his previous funds, Invesco Perpetual Income and High Income . By avoiding technology stocks at the height of the tech boom of the early 2000s, and shunning banks ahead of the 2008 financial crisis, he was been able to deliver long-term returns to investors unmatched by rivals.
We asked investment analysts Style Research to examine the performance of Woodford’s former funds from as far back as their records allow to the date he handed them to his successor at Invesco, Mark Barnett.
From March 2005 until March 2015, Style Research’s modelling gives the Invesco Perpetual High Income fund a cumulative ‘active return’ – the return above its benchmark – of 104.8%.
Nearly all of this was delivered by Woodford’s sector allocation, rather than the particular stocks he selected from within those sectors.
His most famous move, to avoid the banks in the run-up to the financial crisis, was by far and away the biggest contributor to his performance over the period. Woodford on average held 17.4% less than the market in financials over that period, a stance that delivered 25.2% of the active return.
His heavy backing of utilities delivered 22.7%, while 15.9% came from his ‘overweight’ – holding more than the market – in consumer goods, while his relative shunning of the oil and gas sector gained him a further 13.4% of that active return.
This analysis is not comprehensive. It does not, for example, include the performance of the unquoted stocks that Woodford held during his time at Invesco Perpetual.
The long ‘tail’ of such stocks was a longstanding feature of his time at Invesco, and his track record in investing in early stage companies was highlighted by Woodford Investment Management at the launch of the Patient Capital trust. This, his supporters argued, dispelled comparisons with Bolton’s China adventure.
Woodford Equity Income races ahead
Early stage stocks have also been a feature of Woodford’s main fund, Woodford Equity Income , which unlike the trust has topped the performance tables since its launch nearly 18 months ago. And his investment in early stage companies has played a crucial role in those returns.
Figures released by Woodford Investment Management show that of the 14.6% annualised return Woodford Equity Income has delivered, nearly half of that, 6.6%, has come from early stage companies.
That’s a remarkable performance from stocks that make up a minority of the £8.1 billion fund. Underlining this, the two stocks boasting the biggest contribution to the fund’s 16.2% return last year were the relatively-unheard-of biotechnology companies Stratified Medical and Prothena (PRTA.O).
The fund enjoyed a total return on its holding in unquoted company Stratified Medical of an astonishing 491% over the year, boosting the fund’s value by 2.9%. The Patient Capital trust, which also invested but at a later stage, has not enjoyed the same return.
US-listed Prothena meanwhile delivered a 249% return in 2015, adding 2.3% to Woodford Equity Income.
It’s worth emphasising just how impressive this performance is. Two largely unknown companies that at the end of last year made up less than 1.8% of the portfolio now stand just outside the top 10 holdings, and have delivered more to the fund over the last year, in pounds and pence terms, than its £620 million stake in Imperial Tobacco (IMT).
Another illustration of Woodford’s early stage success, so far, comes by comparing the record of Woodford Equity Income with the St James’s Place fund, which isn’t allowed to invest in those stocks.
Last year, the fund returned 7.3%, less than half that delivered by Woodford Equity Income.
Some of that can be explained by charges. Ongoing charges of 1.88% on the St James’s Place fund are much higher than charges in the 0.6% to 0.75% range, alongside a platform charge, that most investors in Woodford Equity Income pay.
But the lack of early stage companies has also had an effect. They represent around 25% of the Woodford Equity Income fund, with around 7.5%, or £570 million, held in unquoted stocks, and a further 8.9%, or £680 million, invested in companies listed on AIM. Rules dictate that unquoted holdings can never exceed 10% of the fund.
And yet Woodford’s early stage investments haven’t all been as successful. As Citywire revealed in November, he demanded US firm Northwest Biotherapeutics launch an inquiry into allegations of financial impropriety against its chief executive and a non-executive director.
The stock is among Woodford Equity Income’s five worst performers over 2015, with Woodford having lost 36.6% of his stake, taking a 0.4% chunk out of the fund’s return.
The story was lent added spice by Woodford’s hiring of a former FBI special agent to advise his firm on its investment, and sparked the kind of headlines Woodford is not used to making.
It highlighted the risks that investing in early stage companies can bring, risks which Woodford acknowledged when launching his fund. ‘I strongly believe that investing in early-stage technology businesses can add meaningfully to the long-term performance of the fund,’ he said then.
‘Not all will succeed – this tends to be a higher risk pursuit than investing in a mature FTSE 100 business, for example. But I will mitigate this risk by keeping individual positions very small in the context of the overall portfolio and, in aggregate too, they will be a relatively small part of the fund.’
While Stratified Medical and Prothena have been responsible for the bulk of the uplift from early stage companies, there have been other notable successes. Estate agent Purplebricks (PURP), which floated on AIM last month with a £240 million valuation, has delivered a 426% return for Woodford, who first invested in August last year when the company was valued at just £21 million. AIM-listed biotechnology stock 4D Pharma (DDDD) meanwhile returned 73% for Woodford last year.
But it’s still early days in the life of both Woodford Equity Income and Woodford Patient Capital, and unquoted company valuations can also be uncertain when those firms aren’t generating profits. Where early stage companies are listed, the thin trading in their shares can meanwhile produce volatility, both up and down.
Track record on small stocks
To get a better gauge of Woodford’s early stage investing track record, we trawled through accounts for his Invesco Perpetual Income fund dating back to 2007.
It shows that ‘bumps in the road’, as Woodford has termed the Northwest debacle, are an uncomfortable fact of life for early stage investing. Among his unquoted investments was Walton & Company, the banking start-up launched by former Panmure Gordon analyst Sandy Chen. Plans for a 2010 stock market listing were shelved and the company ultimately dissolved in 2014. Company filings suggest Woodford’s former Invesco Perpetual Income and High Income funds received some proceeds, although only around a third of their investment, with the Income fund losing approximately £2 million.
Other unquoted companies eventually written down to nil in the Income fund’s accounts include insurance company Synergy, a stake that had been valued at £2 million, and a stake in Nordic Leisure that had been valued at £3 million.
But those disappointments are dwarfed by the early stage investments that do go well, like Allied Minds (ALML). It’s difficult to pinpoint exactly how much profit Woodford made from his investment in the intellectual property company, which he first backed in 2007. He made at least £19 million for the Income fund before Allied Minds’ flotation in 2014. His former Invesco funds, now under the control of Mark Barnett, upped their stake when the company floated, and 2015 accounts for the Income fund show the size of the stake had rocketed from £31 million the previous year to nearly £250 million.
Even successes like these, however, come with pitfalls. The stock was last year hit by short-selling attack from hedge fund Kerrisdale Capital, which dubbed the company ‘a dressed-up collection of high-risk, low-reward gambles’. The company has lost around a third of its value since the attack.
Barnett, who retains the company in the Invesco Perpetual Income and High Income funds but has been reducing his stake, highlighted the problems of thin trading in his October update for the High Income fund. ‘With a limited number of shares in issue, the share price performance of the company has been volatile since flotation,’ he said. The shares remain 80% higher than their 190p flotation price, but have lost half their value since a high of 729p last April.
Shares in online stockbroker AJ Bell have risen by around 190% since 2007, with the Invesco Income fund’s stake growing from £7 million to £40 million over the nine years, although more shares were bought along the way.
Xeros (XSG) is another: the waterless washing company was valued at around £6 million in 2013, and now boasts a market cap of more than £200 million.
It’s also worth noting that with these successes, Woodford’s funds have continued to invest as the companies have grown. Wipeouts such as that suffered by Walton & Co, by contrast, have typically taken place at a much earlier stage in the company’s life, without the positive signs of progress that would encourage further investment.
It is these early stage triumphs that investors in Woodford Patient Capital in particular hope will be replicated. Should the trust get distracted by attempting to raise too much more money at the expense of returns, their patience may start to wear thin.
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