Neil Woodford

Neil Woodford was up until recently the man who made middle England rich. A star money manager that at one time could do no wrong. Of late his fortunes have changed. Since 2017 his fund has hit problem after problem with it culminating in the suspension of trading in one of the main funds he manages. Theres a couple of topics I would like to discuss. We first need to look back at his past to understand why he had such an esteemed reputation and if it was warranted. Then I would like to cover alpha funds and the active money manger myth, whereby regular people can pick active funds to beat the market over the long run, when study after study has conclusively proved that the vast majority of funds do not beat the market. Finally I explore what should you do if you are invested in his fund that has been suspended (not a lot you can do at the moment as its suspended and will probably be suspended for months). 

For an excellent summary of what happened and also some thoughts on how fund industry best buys lists are hard to trust watch this video.

Neil Woodford had a long track record of beating the market, his equivalent benchmark being the FTSE All Share Index. As can can be seen in the below graphic he has appeared to have found the secret formula and had the midas touch to pick the right stocks. Consequently when he left Invesco many retail investors followed him and he set records with the amount of inflows of money into his new fund.

For the first couple of years it appeared to be business as usual, he was once again beating the market.

However as the red line of his fund shows above, gravity began to set in. A series of bad investments, money outflows and negative news meant the fund began to loose any prior gains it made, in fact over 5 years when stocks have been in a bull market, investors are down on their money in his fund and it is gated probably for months. So what went wrong and can he bring it back?

Analysis of Prior record

While it is too premature to say Neil Woodford is finished, I do however personally believe when analysis is applied that Neil Woodfords prior record as a star manager is somewhat overblown. The top graph of £10,000 can look impressive, however when examining the details it is less impressive. Someone broke down the gains Woodford made during the start of the new century and grouped the relative performance into chucks around events (see below). What they found is that Woodford only broadly beat the market during two spells - the dot com bubble and the financial crisis. All other periods it was pretty much on parity with the market (prior 2000 we know he pretty much tracked the market). Many other funds did well during the dot com bubble as dozens of dozens of investors were talking about the mania at the time. And the financial crisis of 08-09 when Woodford avoided the banks was hardly genius. Back when I had little financial knowledge I could tell back in 2006-2007 that things were not right in the housing market (its one of the reasons I started blogging). 

The following quote is taken from this article - https://www.investorschronicle.co.uk/funds-etfs/2019/04/04/should-you-stick-with-lf-woodford-equity-income/

Investors who bought funds run by Mr Woodford at any point after the 2003 bear market and still hold funds he runs today will have underperformed the FTSE All-Share index by anywhere between 25 and 85 percentage points.

This statement really does put it into perspective (in facts its actually got worse as this is only to March this year well before the gating and more losses for the fund). Neil Woodfords returns look spectacular when the £10,000 graph contains the compounding effect however in reality you have only gained if you bought in before the dot com boom (maybe you could have traded the fund at the right times but for retail investors its a case of buy and hold for long periods of time). The £10,000 compounded over time graph makes Neil Woodford appear to be a genius when in reality it was one short period where he made his gains (which was nothing unusual at the time - lots of active fund managers had the same out performance at the time, this is why there was an explosion of hedge funds around 2000 as many also avoided the Dot Com Bubble and became subsequently popular). 

While at Invesco its also hard to tell if the stocks and direction Neil Woodford took was his own original ideas. This is usually the case in many companies whereby low key analysts/programmers/engineers are the ones that come up with the truly original thinking but there is some figurehead/frontperson who takes the praise in the media spotlight. Invesco at the time may have had analysts at the time who were warning about tech stocks, the banks etc with conversations taking place around the office, recommending sectors to invest in and value companies. We will never know but it is clear something went wrong when he was took out of this environment.

One final point regarding his track record was the length in which he managed to sustain it meant that in all probability he would under perform at some point. The statistics of someone being able to beat the market over decades is phenomenally slim (for example the most famous and wealthy stock market picker Warren Buffett no longer beats the market). Always be weary of people who outperform the market for many years as the chances are conditions will change and so will their luck.

Will he be able to Recover?

No one can say but we can analyse the odds and they don't look good. Woodfords fund is well down compared with the FTSE All Share. In order to get back he has to make significant returns in the next 5-10 years. He has never at any point in his history been this far behind that would be my first concern. My next worry is the strategy he has pursued in recent times. He ran into trouble as he invested in many smaller illiquid companies/startups. This was at odds with what he did at Invesco which was to buy larger companies that paid good dividends. Now after the recent troubles he has stated he plans to sell these smaller illiquid companies and move back into FTSE-350 companies. To me this just makes him appear that he made a grave mistake, didn't really know what he was doing and should have stuck with what worked originally. It would not inspire confidence if I had money in his funds. 

In the past during the Dot Com boom when he avoided Tech stocks he said they were in a bubble and that was why he was avoiding them. He got a lot of stick for taking those actions but at least he had a story, likewise avoiding banks because of the sub prime/overinflated housing market. His story this time is weak by comparison. He still states that the companies he bought are massively undervalued and that it is only a matter of time when their value is realised, only this time he openly admits he does not know what will cause this realisation. There is no bubble in a certain sector, no housing bubble. Thats because generally economic conditions are actually quite good; goldilocks conditions. Inflation is low, housing is not in an unsustainable bubble as interest rates are very low, stock markets are not massively over where they were 20 years ago (in the FTSE-100 case at around the same level), unemployment is at multi decade lows, company earnings are good - there is nothing on the horizon that suggests there will be something that will reset to allow his stocks to rise.

Woodford is now also in a bind where he has had to sell companies maybe for prices that are still not favourable even with the gating. This also has entailed extra transaction costs as he sells a lot of existing stocks and buys back into larger companies.

Stick or Leave

Many independent reports have been published stating active fund management never works in the long run. The evidence in support of passive funds is quite clearly overwhelming. Even if you were sceptical of such reports consider that it is actually a mathematical impossibility for active funds as an aggregate to win over passive funds in the long run. If for example the market gives long term returns of 7% then a passive fund will give 7%, with low expenses of around 0.10%. This is guaranteed as they aim to just track the market. Active funds all aggregated together can only make the market return in the long run. Its impossible for them in aggregate to outperform the market as its a zero sum game - for every winning fund there must be a loosing fund in order to match the markets return that they are invested in. However Active Funds can only loose in the long run due to their fee's, those fund managers with their teams of analysts and their expensive tastes cost money, lots of money. With active management this can be anywhere between 0.75% - 2% (and sometimes as in Woodfords case in more expensive platforms such as Hargreaves Lansdown). 

Therefore being invested in active funds means that beating the general market will have more to do with luck of picking the right horse then down to skill of picking the right fund - the odds are always in favour of the house - or in this case the broad market. Over time it has become harder and harder for fund managers to beat the market, there are many reasons why this is. One such reason was in the past many retail investors were invested in poorly managed active funds or tried to stock pick like the professionals. This created many opportunities for the professional fund managers to exploit these mis-pricings and gain an edge. Recently more and more retail investors are buying passive trackers as the cats out the bag that its the best way. This means people in the active fund space are more professional and consequently the market has become more and more efficient making it harder and harder to gain that edge. Household names like Warren Buffett no longer beat the market - a passive S&P 500 tracker now beats him. George Soros who made great returns 40-50 years ago states that back then he had a very amateur operation compared with now but was still able to smash the indexes. Now he has admitted it has got harder and harder and he would have never made the returns now that he made back then. 

While more and more money flows out of active and into passive why do people still believe in active? Firstly there are many who are not aware of all the above. Couple that you have a financial industry that have a vested interest in trying to maintain the alpha cult. If they tell people its complicated, you need our advice for a fee then this is all beneficial for them as it justifies them getting a cut of your money. Secondly many people psychologically can not deal with just getting an "average" return. We all believe we are better than the average, we are smarter than the herd, therefore we want to pick that winner to get us better than average returns. Finally some people get greedy. The graph at the top shows how much more money you can have if you pick right so just like playing the lottery people believe they can hit that jackpot.

If two of the most successful investors of all time admit they are beaten by a simple market tracker than how does someone with little of no financial expertise pick a "star" fund manager? The only way someone does that is by analysing a funds past track record. Usually such a fund has done well for a 5-10 year spell, the financial media hypes the fund, people jump into the fund, economic conditions change and finally the fund usually underperforms at some point. This pattern repeats again and again and there will be others in the future. A popular fund at the moment is Fundsmith, headed by Terry Smith. For the past decade it has clearly outperformed the market and built up a large following. It has been hyped in the media with more and more people drawn to it. If you analyse the makeup of the fund it is highly concentrated into around 30-40 global companies. The story from Terry Smith is similar, he states they buy quality stocks and avoid all the other bad companies in the global index. If it was that simple then everyone would be doing it however it never is. At some point conditions will change, the stocks Fundsmith holds will become out of favour and the returns will lag the index, eventually undoing all the prior performance. Fund managers probably don't care. They churn and burn consumers and get their fee upfront before the rot sets in and have more than enough money to retire on.

So if you own a fund with Neil Woodford should you sell or hold? In the short term due to the gating there is no other option but to hold. The fund has now probably become oversold as its value has plummeted so in the short term you could hold on as it bounces back a bit, but in the long term? Unlike before, there is no track record of Neil Woodford recovering from his current position, now it is a matter of faith if investors decide to stick it out with him. I'm more than happy to review this post in another 5-10 years and eat humble pie if he makes the comeback of a lifetime and turns it around, after all this has just been my opinion on my blog. However I do know for a fact that over the long run Neil Woodford like the majority of his peers are destined to under perform the market. So its not really a question of if you should stick it out with Neil Woodford, its a case of should you stick it out with active fund managers over passive market trackers. If you pick the active side then the odds are quite simply stacked against you. Passive in the vast majority of cases will always win out. It also means you can buy and hold for life with nothing to do or worry about. They call it passive income for a reason.

Why we don't need Manufacturing

A common assumption among many commentators is that Western countries need a manufacturing base. We have these trade and budget deficits because we don't 'produce' anything tangible. I suppose 200 years ago the same people would have said we need an agricultural base and not this 'phoney' manufacturing industrialisation many nations embarked towards. I disagree with Peter Schiff, Americans don't need manufacturing any more than a country used to employ huge numbers of the population in the agricultural sector. They just need to do things that other nations can't. The service sector is not a drag on the economy, its a path to further prosperity and represents an increase to a nations living standards. 

The purpose of conducting trade on a global scale is take advantage of one another's skills. Argentina and New Zealand are rich in agricultural, so we import their produce as it is more efficient than producing our own. Japan has virtually no natural resources so they turned to electronics and car production and export such goods for the exchange of oil or steel for example. China has an army of low cost workers, impoverished by Mao's Communism, they now look to improve their living standards by using Western expertise in tooling, to produce goods we buy here in the West. America has been a nation of great entrepreneurship, producing some of the leading technologies we use throughout the world. Apple, Microsoft, Google - even Facebook - they all came from an American and throughout the world we all enjoy using their services in some instances for free.

The point is a country does not require manufacturing in order to prosper. American Manufacturing lost out to the first wave of Asian tigers such as Japan, South Korea, Taiwan - not because of 'Government Regulation' as Peter Schiff wrongly associates in the video, but because they could do the work better and cheaper than the Americans. They do it so well, that the US exports their Iron Ore for the South Koreas to use, then South Korea sells it back to America in its end form, and it is still cheaper than doing the work domestically. 

The decline of manufacturing in America is not an isolated case. Throughout the West - Germany, France and Britain, the sector has continually shrunk. That's nothing compared with Hong Kong. It's manufacturing base is 10% of the total economy. Yet Hong Kong is an impressive place. I was impressed by how efficient things worked when I visited. The service was excellent where ever I went and cheap. Hong Kong used to be predominately a manufacturing economy along with the other first wave of Asian Tiger economies - Singapore, Taiwan, Japan, South Korea. Now they have all to some degree expanded into a post industrial economy, into services, yet all these countries generally run trade and budget surpluses. 

The fact that the second wave of Asian tigers have picked up the manufacturing tasks - India, China, Vietnam, Indonesia, Malaysia and so forth shouldn't be something to fear, we should embrace it. We all benefit.

Its easy to use emotive arguments to state that paying Asian workers a dollar a day is immoral, but every society needs to begin somewhere, and history illustrates this. 200-150 years ago our Western ancestors lived in conditions we can't begin to imagine. They lived in fear of constant starvation, literally if the weather was bad that year people would starve, it was that bleak. We moved out of these conditions into the relative utopia today by our ancestors working, innovating and building the capital structure we inherit today. They built the infrastructure, knowledge and tools we use today. And as generations move on, a free market improves this process and each generation should be better off than the previous one (excluding Government stupidity).

Take for example a Chinese person. They are beginning this process our ancestors went through, however they can access a wealth of Western knowledge that will greatly speed up this process. For example the Chinese worker on a Dollar a day now, can feed himself and his family while in comparison under Mao millions starved. As China exports more to pay for technical imports they can build roads, lightening fast railways and improve their capital structure like we did. His Children then have access to more education, tools, computers - objects their father never had. Instead of working at the factory for a Dollar a day, they set up a company that competes with the Western firm. This is what happened in many places like South Korea and Taiwan. Now they have their own companies, HTC (I highly recommend their phones), LG, Samsung, which the Children of the similar hard working parents indirectly helped to create. 

The so called humanitarians are currently protesting against such wage rates, but wait another generation to see how it transforms the ancestors of the people who walked before them. It will be a different picture.

The common mistake is that when a manufacturing job is lost, this will deteriorate our living standards. When we joke that everything is made in China, we also talk about the decline of our living standards to come. The opposite is in fact true. Both sets of nations benefit. 

Think about it. Since China has become the manufacturing hub of the world every good conceivable has come down in price. This increases our purchasing power and living standards. It helps China move out of poverty. We move into work that pays better and exchange this other service based products for such goods.

That's not to say its all a bed of roses. People who previously had these types of jobs in the West are displaced. They need to find alternative work. With the advent of minimum wage rates and generous benefit options it has become increasing hard for such people to find alternative work. They are the forgotten minority, the underclass who become stuck in a vicious cycle, created by the plethora of Government experiments. A free market society would find jobs for such people. The Government hampers this process. 

Peter Schiff has also made comments in the past stating that China should send their push bikes to America (indicating a reverse in living standards for Americans as opposed to China). Peter is also wrong on this front and history again has the answer. The UK used to be like America, the most prosperous country in the world, ahead of the game. As we went into decline others became more prosperous. Now if we take like for like, Britain was once America and America was once the China of the world, do I now have lower living conditions than my great grandfather? Relative to Americans conditions may have declined, but over time both sets of peoples living conditions have risen. Its the same with the rise of Developing countries today. Just as America made huge innovations in technology and exported it to the world to use, Chinas rise will also benefit us all.

With 3 Billion people awakening from the shackles of Socialist or right wing Statist Military dictatorships, all that extra human labour will be a great boon for the global economy, just as it has been already. Historically the native Han Chinese are a very entrepreneurial people. When Mao took control, many such individuals fled - Singapore, Taiwan, Hong Kong, the West - and they all prospered. With Chinas embracement towards freer trade I'm willing to bet there are some smart people there that will have some great ideas, products that people will want, innovations that will make our lives better. Jobs we don't even know exist will be created from such ideas. Just as Americas innovators have made our lives better with their products, it will be the same with developing nations as they rise in prosperity. 

As more of the world becomes educated, more service jobs will be created. More wealth will be created at an ever increasing rate. There's only been hundreds of millions in the West over the past Century who have had free speech and markets. Imagine what another 3 Billion people can bring to the equation as they become increasingly educated and freer. 

To contrast markets to Governments look at the technology sector, the industry I work in. It is probably the most dynamic and fast paced industry continually making our lives easier and more productive. Its also one of the few sectors that has no Government interference at all. No regulation. No government agencies monitoring it. Yet it continually increases the quality of goods with more features. We are told that we need regulation and Governmental agencies to 'protect the consumer' condescending people that they are too stupid to manage their own interests. Yet the technology sector flies in the face of such logic. Bad products and companies go bust quickly, and quality always wins out at as consumers are rational and don't need an agency to co-ordinate such an activity. Contrast that with the financial sector - fractional reserve banking instigated by the Government, Regulation after Regulation, Agencies (Moody, S&P, FSA etc), price fixing of interest rates, currency monopolies - its no coincidence that its in a mess. It will always be in a terrible condition and a drag on society with the Governments involvement, meanwhile the technology counterpart continues to efficiently mobilise societies resources effectively using the free market. If you ever need to argue the merits of a free market then this is the example to choose and will stump anyone opposed to the concept of Capitalism. I don't even think the Socialists would dare contemplating nationalising this sector. On the other hand many financial service jobs we could do without. Just like propping up our Steel, Coal and Car industries of the seventies its with finance this time and its counter-productive.

I'm bullish for the Century to come. Sure we all know many Governments are walking head on towards the next crisis of their own doing - stagflation, trying to erode our capital structure and removing individual liberties. Its going to be rough for at least the next decade, probably slightly longer. Going forward however we have a lot to look forward too. Markets will be embraced further, people will see our Governments misdoings. The Socialist and Communist experiment is dead. Thatcher or Regan didn't kill the left, it was the free market. I don't agree with Peter Schiff, I personally align more with Warren Buffets recent statement where he said our children will have better lives than we did. So long as we allow markets not Governments to enhance our lives this will always be the case. Relative decline, sure, but as with the example of the UK's decline each generation has had a better standard of living because we never truly abandoned the free market despite a few wobbles along the way. Look forward to the future, the innovation revolution is only just beginning.

Beware of the Sage

"'If we elected a Congress with intestinal fortitude, it would stop the spending all right!' ... I went to Washington with exactly that hope and belief. But I have had to discard it as unrealistic. Why? Because an economy Congressman under our printing press money system is in the position of a fireman running into a burning building with a hose that is not connected with the water plug. His courage may be commendable, but he is not hooked up right at the other end of the line. So it is now with a Congressman working for economy. There is no sustained hookup with the taxpayers to give him strength."
Howard Buffett, U.S. Congressman 1948

Businessman and Politician Howard Buffett was the father to one of the world's most successful investors in history, Warren Buffett, who would grow up to be the richest man on the planet by earning his wealth purely by investing in companies. From an early age Warren was exposed to the business that would become his passion. Howard worked as a local stock broker which captured the younger Warrens imagination. While other children were playing games, Warren was more interested in business activities, so much so that he would never have attended University had it not been for his fathers influence. He began as an Investment salesman, but as time went by the "Sage of Obamha" amassed billions and become a household name.

However, since the credit crunch began brand Buffett has taken a hit of late. He has lost some of his wealth during the financial turbulence and Bill Gates has resumed pole position as the richest person in the world. His Investment fund, Berkshire Hathway, has made its first loss since 2001 and in the process lost its triple A rating. Despite setbacks, Warren continues to reassure his legions of followers that over the long term all is well and stocks will always do well. It would take a brave person to write off the Sage, but there are signs that Warren is out of step with the times.

There seems to be a contradiction between his advice and his actions. He is famed for calling financial derivatives as "weapons of mass destruction" but recently bought up a pile of such instruments to hold in his investment company. He states that governments are carrying out the correct policies to help the economy through the current crisis, yet openly admits that government bonds are a bubble. Through 2006 and 2007 he warned that many stocks were overvalued along with various other issues that the world would face, yet bought many stocks, including Conoco Phillips, at their peak. The above seems to illustrate a person in touch with global affairs, yet going against his own advice. At the age of 78 has Warren embarked on a personal crusade to save the U.S. and world economy from further collapse, carrying forth his philanthropist work into his investment decisions?

His father was a strong believer in Libertarianism, with a strong distrust of Government. To Howard, Government was always the root of the problem - not the solution. The policies and deficits being proposed today would deeply worry Howard who never lived to see the world monetary system we operate under today. Under a pure fiat system Howard would have quite different investment decisions to his son, as he was always weary of how governments could confiscate the public's wealth through inflation. Gold was his preferred monetary basis and he would no doubt be telling his son about its properties during the times we find ourselves in now. Warren by contrast, views Gold in a somewhat different light, a barbarous relic, which does no good for society unlike stocks. He is no doubt correct on the fact of what both assets do for society, but is he willing to put his own and his clients wealth at risk for the good of humanity?

Warren can afford to be careless. He has an inexpensive lifestyle and has no interest in money, it seems he just relishes the challenge of picking stocks. He has built an almost religious following, but beware, all people are fallible. Throughout history great captains of finance have lost their way. The Rothschilds, Rockefellers and Morgans to name a few. All bounced back, but lost considerable influence and dominance that they once had. Could we be seeing a similar point in history with Warren Buffett? I have no doubt that he has an eye for picking stocks and certainly knows his domain, but what if there are no fundamentals for the asset class in question? When government embarks on a policy of preventing liquidation and printing money by increasing government spending, this does not create the conditions required for a strong equity market. Japan tried this and their market index is still under half its measure from 20 years ago. During the seventies the US stocks went no where for 15 years, in inflation adjusted terms you would have lost money.

Despite Warren seeing inflation down the road, he seems to quietly ignore this damaging effect on business behaviour, choosing to believe in the fact that Coca Cola or whoever will be able to rise above it. Howard would see something different in the climate we are in. He would see the government in the process of hampering the private sectors ability to function along with the government confiscating the public's wealth through inflationist policies. He would also worry about the current monetary system we find ourselves in. He never lived to see a full global fiat system, but he understood the history of it. As he once said;

"But first let me clear away a bit of underbrush. I will not take time to review the history of paper money experiments. So far as I can discover, paper money systems have always wound up with collapse and economic chaos."

Could we be facing further dislocations to come, or are we through the worst as many are suggesting? We have not even begun in this recession even as many proclaim that a recovery is within sight, as the clutching at straws begins. There is much more chaos to come and we are due a currency crisis. The dollar is a bubble along with other currencies. The Yen trade still has huge amounts of money overseas and as further losses accumulate, these will no doubt have to be covered putting further downward pressures on already weak currencies. Whether we see the end to the current monetary system or a transition to an alternative is another question. The authorities can only buy time, they can't fix the system and as the quotes sixty years ago suggest, paper money can never survive indefinitely. As for the question on whose view to take, Howard or Warren, Howard clearly understood economic theory and history better than his son. Investors beware, Warren may have a generous heart in attempting to save the world but many of his followers will not have as deep pockets.