When value and magic run out….

Tuesday, 18th June 2019

When value and magic run out….

Fly too close to the sun and you run the risk of the heat melting the wax that attaches the wings to your body….

The subsequent fall to earth will be both spectacular and devastating….

Students of Greek mythology will know that Icarus found all this out for himself via painful experience….

Students of the markets will recognize that Neil Woodford is currently experiencing an ‘Icarus’ moment of his own….

  • A star turn….

For a long time, fund-manager Neil Woodford could do no wrong. He flew high – a mere small dot circling in the blue sky overhead….

He banked big profits for his investors at Invesco between 1988 and 2014 – profits well ahead of those posted by the opposition….

So much so, he was seen in financial circles as a man with the Midas touch….

His performance was widely feted, his sage pronouncements much-coveted, and his every market move pored over, analyzed and frequently duplicated….

Woodford was ‘smart money’. The man it paid to follow. A luminary among lesser money-managers. A ‘star’ in the financial universe no less….

When he branched out to form Woodford Investment Management in 2014, he enjoyed the backing and support of Hargreaves Lansdown – the  largest investment platform in the country….

Private investors were swift to get behind Woodford. And for two-years their faith paid off. Woodford delivered returns of 20% – at a time when the average return produced by other fund managers amounted to less than 10%….

Then the wax started to melt. And Woodford quickly lost altitude….

His funds lost value, capital under management diminished as investors pulled out and ultimately, Woodford took the recent controversial decision to suspend redemptions from the Woodford Equity Income Fund….

Now his backers Lansdown Hargreaves have watched their share price drop by 15%+ in less than a week as the crisis unfolds….

CEO Chris Hill is talking about waiving a bonus of £2 million+….

And when a big financial cheese starts talking about not taking his bonus, you know it must be bad….

  • Falling to Earth….

Let’s be clear, Woodford has not lost his touch completely….

Recent successful picks tell anybody who cares to know that Woodford can still find a hot stock for his followers – one that can be bought cheap and then take off….

Relatively recent purchases of stock in Purplebricks, Burford Capital and Hostelworld – all big winners for Woodford, his fund and his investors – say that much….

But there have been notable recent failures too in the Woodford portfolio – previously solid companies on which the wheels have come off with Woodford and Co still stuck in the back of the van with a load of skin in the game….

Think Provident Financial and a 67% drop in its stock price when the company announced a profit warning and a reduction in the dividend….

Think AA and a 34% loss when that company made a similar announcement….

Whatever good moves Woodford has made over the last couple of years have been overshadowed and ultimately cancelled-out by things that have gone wrong….

It’s the type of thing that a fund manager might put down to ‘poor market conditions….’ And there’s been a fair bit of that kind of talk.

But there’s more to it than that. And we can learn something from the situation….

  • A value man….

In seeking to try to understand this situation, it is important to acknowledge what it was that powered Woodford’s star and enabled it to rise in the first place….

It was his ability to seek out ‘value’ in the market. And not just that. It was also his ability to avoid companies that were over-played and expensive….

Part of the stellar Woodford back-story is that – unlike most – he was well out of tech stocks ahead of the dot.com bubble bursting in 2000….

He also looked good in the aftermath of the last financial crisis – his portfolios unscathed by the losses incurred by banking stocks….

Woodford was a ‘value’ man. He bought good stuff cheap and watched it climb higher – whilst avoiding expensive and exposed stocks ready to tank….

It’s not a bad strategy – if you have the nous and savvy to pull it off. It was certainly a winning strategy. And probably a strategy Woodford should have stuck with….

But by the time Woodford and his funds hit trouble a couple of years back, things had changed….

The markets – awash with a tidal wave of fresh capital produced by a decade of the loosest monetary policy in the history of human civilization – had been rising relentlessly for 8 years….

Between 1st September 2009 and 1st December 2017, the FTSE 100 had climbed from, 3830.10 to 7687.80 – a gain of just over 100%….

Great news for most investors, of course. A rising tide lifts most boats….

But by 2017, how much value would there have been left in the market for a big value player like Woodford to find?

Some, perhaps. But certainly not much….

  • When the old magic fails….

Perhaps that’s what prompted Woodford to change his investment style – to switch  away from out-and-out value seeking and to focus instead on small-cap and unlisted companies….

Before the recent well-documented troubles, Woodford’s Equity Income Fund contained stocks of 100 small and unlisted companies….

In the absence of value in the mainstream indexes, Woodford had shifted his value hunt to other areas – areas in which he was unfamiliar and areas where his methods failed to replicate the old magic….

Perhaps he hoped to stumble over a big winner across the long-term – the next Microsoft. (And it might still happen, of course)….

Perhaps Woodford believed methods that had worked with established companies would be equally effective with smaller and riskier companies just setting out….

Perhaps he believed a little too much in his own legend….

Having built his reputation on stellar returns, beating the market and beating the opposition – hands down for years – perhaps Woodford felt the pressure to maintain that reputation long after the value had gone out of the stock market….

We may never know. But Woodford is not flying as high as he was….

He might bounce back. I wouldn’t write him off. But his recent fall from grace highlights three investor lessons that it will benefit us all to bear in mind….

  1. Stick with a winning style – and hold off when market conditions are against it….
  2. Don’t believe your own hype – you are never as good or as bad as you think you are….
  3. What goes up almost always comes back down – the moment you forget this is the exact right time to brace for impact….

That’s the truth of it as we see it….

All the best,

Dave Gibson

Money Truths