From The Chair: Woodford vs. the armchair pundits

With all the column inches currently appearing about Woodford, we are seeing an excellent illustration of the pundits’ ability both to be wise after the event and also to draw incorrect conclusions.

In my view, Woodford has pursued a laudable investment strategy, the validity of which is supported by the Government’s Patient Capital Review announced in 2016 to come up with solutions to the lack of patient capital available in the UK to support the development of the UK’s significant businesses of the future. The offering for Woodford Patient Capital can be seen by clicking on https://static.woodfordfunds.net/prd/2015/02/woodford-patient-capital-trust-plc-prospectus1.pdf and turning to page 33, which contains a succinct description of the amazing wealth creating opportunity available to the UK, but which for decades it has been feeble at commercialising.

The Problems

Where the problems for Woodford have arisen, in my view, are in execution, namely:

i) Fund Structure

The structure used for the suspended fund is an Open-Ended Investment Company, holdings in which are tradable daily subject to trading not being suspended. This is not a suitable structure for a portfolio containing unquoted investments, which by their very nature are illiquid - this problem can be avoided with, say, an investment trust, which does not require sales of underlying investments if a shareholder wishes to sell his holding.

ii) Big Bets

Fund managers are prone to say that they must invest sizable amounts per company because that is the only way to ‘move the dial’ on the performance of their fund. However, early stage projects which need tens of £millions of funding have the drawbacks of a) being exposed to competition because other people also spot the opportunity, and b) need to be hugely successful if investors are to ever enjoy a level of return which justifies the risk taken - such projects are frequently promoted by investment bankers attracted more by big fees rather than investment merits.

With a suitable investment template, it is perfectly feasible to find businesses with solutions for addressing global problems, but where investment of less than, say, £10M is required to develop a profitable business to provide the platform from which to build a sizable multinational business - although further significant funding may be required, it should be able to be deployed in a way which is much lower risk (eg making a well thought through strategic acquisition) and the timescales for returns are much shorter.

Risk

The challenge for investors is that at the heart of capitalism lies a long term process of creative destruction resulting from finding better ways of doing things - the latter generally emerge via newer and smaller companies based on harnessing new technologies - larger companies have generally responded by acquiring the latter, but that means that those larger companies which fail to both make such acquisitions and also leverage the acquisition successfully will ultimately fail - this process does not happen at an even pace over decades but conforms to the Kondratiev cycle, which happens over c.60 years and is associated with new technology - I believe that the global economy is currently in the early stages of a Kondratiev cycle turning point driven by the impact of the 4th Industrial Revolution. Examples of long established sectors currently experiencing turmoil due to changes in technology are retailing and vehicle manufacturing, demonstrating that when fundamental technology change is under way, being large is not necessarily an indicator of ongoing success.

In my opinion, the solution to the above backdrop is for investors to look for fund managers which a) have an investment template which makes commercial sense in a world which is in turmoil and b) build barbell portfolios ie portfolios containing a lower risk portfolio alongside a higher risk portfolio, with the balance between the two being such that the chances of preserving wealth in real terms are very high and the chances of achieving above average returns are high. With regard to the investment template, my own preference is for companies which improve the productivity of their customers, on the grounds that when economic times are tough, the need for such companies becomes greater!

To borrow from advice in a recent investor newsletter article about the impact of automation on jobs, ‘just own the damn robots!’.