Once upon a time, Neil Woodford was the most celebrated fund manager in the UK. Today, Woodford bashing has almost become a national sport.
So what mistakes did he make and, more importantly, what can we learn from the great man’s downfall?
[Warning: This article may contain irony]
Mistake #1 – Not hugging the benchmark
Woodford’s first mistake was to not hug his benchmark (i.e. the market index) closely enough.
His portfolio was consistently weighted towards sectors and stocks which he thought offered the best value, rather than those that were heavily weighted by the market.
Neil should have known better, because every sensible investor knows that the best way to avoid underperforming the market is to make your portfolio as similar to the market as possible.
If you do that then you cannot be criticised when your portfolio performs badly. You can simply point to the equally weak market performance and say “it’s a bad market for everybody”.
Of course, doing exactly what the market does rules out the possibility of outperforming the market, but that’s a minor inconvenience if your main priority is to avoid criticism.
The lesson here is obvious:
If you want to avoid occasional bouts of underperformance and criticism then give up trying to beat the market and just copy it instead.
Mistake #2 – Making high conviction investments
This mistake is closely related to mistake #1.
Woodford is well-known for having almost 10% each in both AstraZeneca and GlaxoSmithKline. This sort of high conviction bet in pursuit of outperformance is just asking for trouble.
Clearly, if you want to avoid criticism when an investment goes off the rails then you should have no more than two or three percent of your portfolio in any one company.
That way, if something does go wrong with a particular company it won’t make much difference to your portfolio.
You’ll be able to inform everyone that problems with that one holding don’t matter because you’re “well diversified”.
That may be true, but having tiny amounts invested in each company means that your portfolio will need to invest in more companies, and at some point it will begin to resemble the market.
So the chances of outperformance will go down, but then again so will the chances of underperformance and criticism.
Neil should definitely take note of this lesson:
If you want to avoid occasional bouts of underperformance and criticism then don’t make big bets. Don’t put more than 2% into any one company and don’t invest heavily in companies you think are attractively valued.
Mistake #3 – Giving the impression that excellent returns were inevitable
This is perhaps Woodford’s biggest mistake.
If you are consistently rubbish as an investor then nobody will bat an eyelid if you underperform because it happens so often.
But if you have the audacity to beat the market by about 5% per year, on average, from 1990 to 2015, as Woodford did, then you should know better than to expect an easy ride when things go wrong.
One way to avoid consistently beating the market is to track the market, but we’ve already covered that route to the quiet life.
Another approach is to make sure you always beat the market and never ever underperform. Of course this is impossible, unless you do a Madoff and run a ponzi scheme.
If you do that you can beat the market every single year for decades, at least until the whole scheme collapses and everybody is left penniless.
With that in mind, my final lesson for Neil and other investors is this:
If want to avoid criticism when you underperform then either:
- Only ever outperform the market by a small amount for a short while, so that when you do underperform nobody can be bothered to criticise you, or
- Do a Madoff and run a ponzi scheme so that you are guaranteed to outperform the market every single year, forever (or at least until the scheme collapses and everyone is left penniless).
The problem is (probably) not Neil Woodford
Hopefully it’s obvious that my list of Woodford’s “mistakes” are tongue-in-cheek and that they are in fact exactly what you should expect to see from a well-run actively managed portfolio.
I’ll rephrase each “mistake” in a more positive light:
Positive feature #1 – Having a portfolio which is very different to the market index.
Any differences will inevitably lead to periods of underperformance, but those differences are absolutely required if you want better returns than a passive index tracker.
Positive feature #2 – Have some investments which make up a significant portion of the portfolio.
2% or so invested in 50 or more companies is a very low risk way to invest, but I think it’s much harder for that sort of approach to beat the market (and if it isn’t going to beat the market, why bother?)
There are limits to this line of thinking of course, and I’m not saying that 50% invested in one company is a sensible approach.
For example, in my portfolio I trim back any holding which exceeds 6% of the total.
Woodford seems to be comfortable with a maximum of around 10% invested in any one company, but much more than that is probably too much for most people.
Positive feature #3 – Having a long track record of relatively consistent outperformance, with occasional periods of underperformance.
As an active investor you simply must get used to the idea that occasional bouts of underperformance are inevitable if you’re trying to beat the market.
If you cannot stomach even short periods of underperformance then you should probably stick to index trackers.
But if you can accept short periods of underperformance with stoic calm, then you may just succeed as an active investor.
And by “short periods” I mean anything up to a few years.
That’s longer than most people’s definition of “short periods”, but underperformance over anything less than five years is simply not relevant.
Over that sort of timescale, changes in share prices and fund values are driven not by the true, fundamental and intrinsic value of the investment, but by the fickle nature of other stock market investors.
So if your portfolio of shares or funds underperforms over a week, a month or even two or three years, there may not be any problem at all.
But if your portfolio underperforms over five or ten years then yes, perhaps it’s time to ask the portfolio manager (whether that’s Woodford, another fund manager or yourself) if they know what they’re doing.
Has Neil Woodford lost it? It’s too early to tell
As for Woodford, I have no opinion on whether he’s “lost it” or not because his period of underperformance is so short.
I think the sensible thing to do would be to wait a few years and then see how he’s performed over the previous five years.
If he’s still underperforming by that point then yes, perhaps he has lost it.
A few years have passed since I wrote this article and as you probably know, Woodford was very much at fault.
The best analysis I’ve seen of his errors was this presentation by Ed Croft, CEO at Stockopedia:
There are also a couple of books on Woodford’s demise, which really dig into the details of just how badly things went wrong.
Long time reader, first time poster. Neil Woodford is exactly what the UK investment industry needs. A stock picker who stands by his decisions, doesn’t hug the benchmark and doesn’t charge excessive fees. I don’t get the point of this post?
John Kingham says
Hi Sam, thanks for commenting.
I agree with you, Woodford is exactly what the fund management industry needs. I also agree that not hugging the benchmark, making (reasonably) large bets and having a long history of success are good things.
I wrote this post because I saw the barrage of criticism fired in Woodford’s direction and multiple articles asking whether he’d “lost it”. I thought the degree of criticism and doubt was excessive to say the least, so I wanted to write a counter-piece.
So the point of the post was to point out that periods of underperformance are inevitable and that many of the things that Neil was being criticised for (making relatively large bets, investing in somewhat troubled and unloved companies) are probably positives, rather than negatives. That’s why I included those things as “positive features” in the second half.
I think my attempt at humour and irony in the opening half of the post (i.e. I meant the opposite of what I actually wrote) has made my true intent less clear!
akingbe olatunji says
if a man has outperformed the market average for such a long period of time, i think it is wrong and unfair to question his ability or criticize him for this short period of under-performance. first, i am very sure the guy never said he was going to out-performed the market all the time, and as a value investor you should surely know that no strategy out performed the market all the time. so, what is the hue and cry all about? from 1990 to 2015, if you can do the math, you will see that the man has created much more wealth for his clients than what they could have gotten investing in the market average. the essence of investing is not what happens in the short term, but what you are able do over the entire period. i am very sure the guy knows what he is doing and his statement which you quoted shows he does. i think what we should do is not to question the guy’s ability but to let others know that this kind of thing comes with the territory
John Kingham says
Hi Akingbe, I totally agree.
Hippidus Hoppidus says
Criticising an active fund manager for “not hugging the benchmark” and for “making high conviction investments” is bizarre. If the aim is to follow the market average, there is no point paying a premium over a passive index. It is counter intuitive to reference random walk for a site dedicated to the methodology of value investing.
John Kingham says
Hi HH, I totally agree. The article was in fact ironic, although it looks as if my version of subtle irony doesn’t come across well in writing!
So to clarify, I think that not hugging the benchmark, making high conviction bets and having a long track record of success are all good things.
I have now added a note to the top of the blog post warning readers that the article is a (very) deadpan attempt at irony (which sort of kills the joke, but better that than have readers repeatedly accuse me of criticising Woodford!)
John, I think his mistakes can be simplified in this manner and perhaps his former successes at Invesco Perpetual had more to do with the organisation around him at the time rather than his own ability, although it would be very difficult to substantiate that view of course.
To simplify :-
1. He buys cyclical stocks at their peak – there are so many examples, keeps buying them on the way down and then capitulates and sells at the bottom – Centrica, Rolls Royce. He’s just making the same mistake with the builders and estate agents, who’s top management are unloading huge swathes of their equity after and eyewatering 10 year property boom.
2. He buys into over indebted companies and companies that he has no knowledge of their real potential (biotechs — North West Biotherapeutics; Circassia, — Venture Capital Investment companies – Allied Minds — heavily indebted companies The AA; Capita …..the list is long. He also buys companies with uncertain customer bases – Provident Finacial – half their customers have no credit rating.
3. He buys too many unquoted companies and just too many companies overall — 42 of the 135 stocks in his “Equity Income” portfolio are unlisted companies and he buys increasing tranches of these 42 to justify increasing their valuation and therefore inflating the fund, when it’s very difficult to put any real value on the 42 at all, as they are not tradeable.
It’s also strange that there are more unlisted companies in his Equity Income Fund than in his Patient Capital Fund. Given that the 42 don’t provide the shareholders any income (no dividends) and are mostly loss making, it’s questionable under a trades description why they are in the fund at all.
135 stocks also seems like an impossible task to keep track of and properly analyse.
John Kingham says
Hi LR, I thought you’d have a few negative words to say on Woodford! For now I’m sticking to wait-and-see approach. We’ll know in a few years whether he’s a duffer or the real deal.
John, It’s OK to class them as negative, however, that’s not really my intent, I prefer to look upon them as akin to facts really. When you see it happening, it is a fact isn’t it?
You’ve got to feel sorry for someone who launches an IT with the word patient in it’s title and still get’s criticized for short term performance! And it’s not had the tough run that his funds have.
John Kingham says
Good point. Perhaps a more fitting name would be “impatient” capital? Impatient for gains… that might actually work as a marketing slogan.
The best way to get rich is charge a performance fee when you outperform the market. Make it clear to your clients this fee is not payable if you don’t. Then make out like a bandit because you can bet on outperforming the market about 50% of the time randomly.
John Kingham says
Or just charge a fee regardless of performance. Unfortunately I don’t think there are any realistic alternatives. It would be nice if a fund could charge a fee on outperformance over say 5 years, but who’s going to wait five years before getting paid?
Yet they always tell us to take the long term view. On their fees apparently the long term is not acceptable.
Gilbert Hall says
Is there any competent analysis of Woodford’s lifetime investment record to date? All I can find is chatty stuff that doesn’t get one anywhere. I like your ironical article though. I see it as an attack on the hot air that often passes for investment advice and not really about Woodford at all.
John Kingham says
Hi Gilbert, you’re right, the article is definitely an attach on the short-termist (hot air) mindset rather than Woodford.
As for a decent analysis of his track record, there are a couple I can think of.
The first is an attempt to compare Woodford to the FTSE Equity Income index:
Let’s set the record straight – via Finalytiq
The second is from FE Trustnet and looks at the best funds over 10 years (from 1999) on a risk-adjusted basis using the Sharpe Ratio:
The funds that made the best risk-adjusted returns
Personally I quite like the Sharpe Ratio. It’s simple to calculate and seems to tie in with common sense about which funds give better risk-adjusted performance.
Gilbert Hall says
Thank you! I like the first article, even though it doesn’t attempt to work out any probabilities. It looks to me like Woodford’s results are random, but that he got lucky early on. If you have hundreds of fund managers doing different random investing, some are going to be lucky and a few will be very lucky.
The Sharpe Ratio is good, but you still need to decide somehow whether the results were merely due to chance.
John Kingham says
The issue of luck/skill in active fund management is unsolvable.
Even if you do find a manager with a 10-year track record that is clearly based on skill, it won’t automatically follow that the same skills will lead to outperformance over the next decade. Perhaps the particular skillset just happened to work well in a particular economic environment, or perhaps the manager’s skill will decline because they get older, richer or just disinterested in doing the same job for another decade.
In the end it can only ever come down to a combination of track record and faith, and I think that’s the best that fund investors can ever do.
Hence the need for diversification across multiple funds, whether your strategy is active or passive.
Excellent article John on a matter which is currently arousing so much interest.
lR makes a good point about the team around a fund manager. It may be the ability to bounce ideas off competent experienced colleagues that can widen the perspective and ground the wider excesses of a manger’s ideas.
But to suddenly invest a torrent of new money, perhaps at market highs, is also a challenge, which few of us have experienced. Do not envy Neil that job! Wonder how he sleeps nights?
John Kingham says
Hi Magneto, thanks. Regarding the team, Woodford has a video on that too:
As for new money, yes I’m sure that with many billions to invest, finding large enough pieces of large enough companies to buy is a headache.
And sleep, I don’t think he has a problem with sleep. He’s been managing money for almost 30 years so he should be used to the pressure by now, and I’m sure he can afford a very comfortable bed.
Eugen N says
Everyone makes his share of investment mistakes, Woodford included.
The only thing that surprised me was Provident Financial. Woodford knew they are changing their business model, but it seems to me that he did not understand how important were those self-employed people who’s jobs were to collect money and offer new loans.
Not only that but he bought more shares! That was madness!
John Kingham says
Hi Eugen, I agree; everybody makes mistakes and investors shouldn’t be too quick to jump on the Woodford-bashing bandwagon. If his skill has left him then his performance will show it over the next few years.
Colin Overton says
Woodford needs to do better. In the last 2-3 years many of his investment vehicles have under performed, some badly. It’s Ok to be a contrarian, proved you are right over the medium term. His reputation is now less than it was. Can he turn things around, yes. I still hold three of his investment vehicles but have sold part of one and am looking hard at the others. I will hold but at reduced levels. Woodford has, in the past, impressed in hard times, not good times. I have a feeling we, I, might need Old Neil in the next years.
John Kingham says
Hi Colin, the big event that Woodford built his reputation on was the way his funds stood up during the dot-com crash, largely because he wasn’t invested in out of favour “old economy” companies rather than expensive dot-coms. So yes, his reputation was built on outperforming in poor markets.
That didn’t really repeat in the financial crisis, where his funds fell as much as similar funds. And now his fund is underperforming in a relatively benign market. It’s not a good trend, and investors in his funds are now experiencing the negative side of investing with a contrarian rather than a benchmark hugger.
For me the jury will be out until we have five years of performance data for his new funds. Then we’ll have a better idea of whether it’s time for him to retire or not.
Nick Warren says
Woodford made the very basic mistake of overlooking the downside impact of sentiment on a closed-end instrument. Investment Trusts starting off with good idea are undermined if sentiment turns against the idea and pushes the price below NAV into a discount. Trusts that possess positive sentiment move to a premium and had this happened Woodford would be in an entirely different position. The bottom line with him seems to be is he not extraordinary and is merely a bog-standard value investor who earned his spurs over a prolonged period when that strategy worked. There are very likely too some mischievous bears out there ready to amplify short-term negative sentiment to buy back their holding at a lower price. To play trusts like WPCT entails buying on the dips and taking partial short-term profits on the peaks. Never buy good idea trusts at the outset either. Buy later at a discount if one materialises. If it doesn’t write it off like Mr Buffet does i.e. say to yourself “good company / investment…. but it never moved to a good enough value proposition for me to buy it.”