One of the principal drivers of the startling outperformance of his funds was the fact that for many years before the global financial crisis he refused to own shares in UK banks, as he felt that a ‘slump’ was imminent.
But Woodford disclosed that for the first time since 2003, he has bought a UK bank stock, HSBC, which he has been building up since the tail end of last year and which now accounts for 2 per cent of his portfolio.
He commented, ‘I have been out of banks since 2003, but HSBC is undervalued. It is a systemically important bank. Now, of course it is exposed to a lot of the problems the other banks are exposed to, and there is no doubt the management did some stupid things. The problem for the banking sector generally is that the regulatory requirements to retain capital could change at any time.
‘The difference is that HSBC has the capacity to build up its capital base, but also to pay, sustain and grow its dividends. But HSBC on some measures is rated worse now than it was at the height of the financial crisis – that is how cheap it is. The management get it, they have learned from the mistakes of the past.’
He added, ‘What is different about HSBC now relative to the other banks is that HSBC is much further along the road to repairing its balance sheet than any other UK bank. It has written off 12 per cent of its balance sheet, Lloyds have only done 6 per cent so far.’
Woodford is also a fan of insurance company Legal and General, saying that ‘it is the first time I have bought an insurance company for many years, but it is very attractively valued at present’.
He professed that he sold his holding in BP a week before the Deep Water Horizon oil spill that has cost the company billions. But this wasn’t due to foresight on his part, rather because ‘I felt that the company would soon struggle to pay dividends’.
He commented: ‘Shell and BP have been have been paying and growing their dividends from the proceeds of asset disposals, and they make up 20 per cent of all the dividends in the FTSE 100. But the reality is that paying out dividends by selling the family silver is not sustainable. When I started my career in fund management, if you heard that a company was paying a dividend but not through earnings, an investor would be suspicious for the future.’
On the prospects for the two oil majors in the medium term he remarked: ‘I keep hearing about oil companies going to cut capital expenditure, but they haven’t yet. And when they do, that stops production levels growing, which doesn’t help grow dividends. I don’t own BP or Shell, and I won’t own them until they are much better value than they are now.’
Still bearish on the UK
Woodford said he is ‘not a bull’ on the prospects for the stock market or the UK economy. ‘What we have seen in the market and the economy is the quantitative easing policy of the UK central bank creating asset price rises and inflating the value of every asset. The growth in the stock market and the wider economy is because of QE, not because of particularly improved fundamentals. Now QE has outlived its usefulness, and is starting to be unwound, but policy makers are worried about what will happen.’
This has created, according to Woodford, a scenario where huge swathes of the UK stock market are overvalued.
‘Mid caps have never been more expensive than they are now. And some sectors, such as tech and biotech are the most overvalued, which is probably reflected in the pullback seen in those sectors in recent times.’
He believes that while there are not many parallels between the economic climate of today and that of 2007, one thing that is similar is that the bull market in equities is ‘at the mature stage’.
Added Woodford: ‘Investors have to tread very carefully, whereas because of QE they haven’t really had to tread carefully for the last five years. There is some remarkable overvalue – look at Asos, its share price has almost halved.’
Woodford and the dotcom bubble
Woodford’s reputation as the top fund manager of his generation was at least in part forged by his shunning of technology stocks at the turn of the millennium.
While that decision may look obvious in hindsight, Woodford reflected that at the time he was seriously questioning himself.
‘The pressure was enormous,’ he revealed. ‘There was not a day where I wasn’t, literally, questioning my sanity. I would wake up and see the market had gone up, and think either I am going mad or the world is going mad. And thinking everyone but you is mad is a sign of madness.’
Woodford retains his belief that two sectors which have long been favourites of his, tobacco and pharmaceuticals, continue to offer compelling value.
His view is that ‘tobacco has been undervalued for 20 years, and I have held it and made money from it for 20 years. People used to say to me, you are mad, tobacco companies are getting sued, they will go bankrupt. I said, they will just sell more in emerging markets. Then people said you are mad, the government are putting the taxes on tobacco up, and I said, well the tobacco companies will put the prices up in emerging markets. Sometimes I think you could get bored looking at my portfolio, because it doesn’t change much. Tobacco has always been there, but tobacco companies are still very cheap.’
Woodford on Pfizer’s bid for AstraZeneca
He told What Investment that the largest position he has ever owned in any one company is his current holding in AstraZeneca.
On the prospect of a takeover by Pfizer, he commented: ‘The current takeover offer does not reflect the long-term value of the company. Some people haven’t liked AstraZeneca for years; people were calling the management lunatics for the level of spending committed to research and development. But I didn’t think they were lunatics and now it is paying off. The key to the valuation of AstraZeneca is its pipeline of new drugs. People talk about technology companies, well AstraZeneca is immersed in technology, but people don’t regard it as a technology stock because it doesn’t have a bloke in jeans and a T-shirt representing it.’
He added, ‘It’s a choice between short-term profit and the longer-term gains that can be made. Now I invest for the long-term, but most fund managers have a time horizon that doesn’t extend beyond the length of their nose. All of the buy-side analysts have been wrong on AstraZeneca for years. If you listened to them, or paid attention to some of the research we brought in, you would have sold AstraZeneca at £20 a share. But I am not a marketer, it’s not what I do: I am here to tell the truth.’
Woodford’s investments in start-ups
Another sector of which Woodford has been a fan for many years is start-up companies, both quoted and unquoted. He confirmed that his new fund would, as his previous fund had, up to 7 per cent in very small companies including unquoted companies.
‘I like early-stage businesses. The UK is the best country in the world for innovation and scientific advance, we have the three top universities in the world for it, and a reputation around the world that no other country has. But as a country we have been rubbish at turning that science into a business, but that is where the best opportunities lie.’
Added Woodford: ‘The problem for the companies is capital provision; there is a lack of capital, but also the wrong sort of capital. Venture capital wants a defined exit point, of say five years, and the investor wants to be able to harvest the technology. The timelines don’t necessarily match. That creates a problem, because the innovators, the extremely bright scientist and researchers, have to spend time getting the next lot of funding, rather than on the technology. This means the technology gets developed in stages, it takes too long and constrains opportunities.
‘While changing that is socially useful, I do want a return. I am not in this for totally altruistic reasons. The demand for capital is high, but the supply of capital is very low, and you don’t need more than an O-Level in economics to understand that in those circumstances there is a lot of value to be had for investors.’
Woodford ceased managing the Invesco Perpetual Income and High Income Funds in March. Since then he has been running a portfolio of £3 billion for clients of St James’ Place Wealth Management. His new fund, which is available to private investors from 2 June, will be called the CF Woodford Equity Income Fund.
Darius McDermott, managing director at Chelsea Financial Services, which organised the dinner at which Woodford was speaking, remarked that there has already been a high level of interest from his clients looking for exposure to the fund.
‘Over the years I have seen so many of my clients’ portfolios where they have had £5,000 in one fund, £5,000 in another, £5,000 in another, then you seen one holding which is £50,000 – and that would be Woodford. We expect to see the money come in, some people will switch into the funds from the old Invesco Perpetual fund, some will be new money, but demand will be strong.’