Neil Woodford has grown the Invesco Perpetual High Income fund to £7.96bn. Kira Nickerson asks if the fund's popularity will impact on its ability to produce a solid performance in the future
Neil Woodford's Invesco Perpetual High Income fund has become such a staple investment in recent years that it has almost tripled in size in less than five years to now be the largest retail investment fund in the market today. At £7.96bn in assets, even five years ago the fund was large at £2.7bn, highlighting not only the manager's solid return profile over the past few years but also his increasing popularity. In fact over the first quarter of 2007 alone the portfolio gained a £1bn, with Morningstar recording the fund had £6.9bn in assets as of 8 January.
Concerns have been raised repeatedly as to whether or not Woodford can continue to manage such a large amount of assets because, if the portfolio continues to grow at its current pace, it could exceed £10bn before the autumn - and that is just one of Woodford's funds. His smaller Income portfolio has also benefited from good performance, as well as a steady flow of investment, boosting it to some £5bn in size. He also manages more on top of these two retail portfolios, including a segregated mandate for St James's Place.
Invesco Perpetual and Woodford's stance is his management style makes running such large funds possible. While an £8bn fund in the UK retail investment world is a rarity, there are much larger portfolios in the US, while in the UK institutional funds can be larger, life funds can be several billion pounds, not to mention with-profits.
When Fidelity Special Situations approached £6bn in size last year, the group moved to split it in half to keep the size under control but, ahead of the split, manager Anthony Bolton had moved weightings in the fund towards a higher market cap to help with capacity constraints. With a large portfolio one of the elements the manager must contend with is potentially owning a large amount of a holding company. Woodford too appears to have done just that, upping his weightings to large caps and the mega cap end of the market. As of 30 March 2007, Invesco Perpetual High Income had 31.8% in companies with a market cap of £20bn or more and a further 11.5% in companies between £10bn to £20bn, as well as 17.2% in firms between £5bn and £10bn in size. This compares to just a year ago when the fund had 16.5% in companies larger than £20bn and just over 20% and 18% in those £10bn to £20bn and £5bn to £10bn in size respectively.
However, Woodford denies the mega cap stance has anything to do with the size of his fund, and instead says this is where he currently sees value in the market. "The largest companies in the index look more attractive to us now in valuation terms than they have for a long, long time," he says. "We're not afraid to have large stakes in individual companies, indeed we hold several more than 3% stakes, so it has nothing to do with this at all."
Another point brought up in favour of his capacity is that he operates a buy and hold strategy, as well as being contrarian in style, leading him to have a low turnover level in the fund, as well as buying when others are selling. In fact, at times the turnover level in High Income is as low as 15% per annum with Woodford sticking to his main bets for years, such as his current stance with utilities and tobacco stocks, a play he has held since the late 1990s.
Today utilities make up 25.5% of High Income, his largest sector bet, followed by consumer goods at 20.9%, which includes tobacco stocks. In fact three of his top 10 holdings are in tobacco, Reynolds American at 5.3% of the fund, 5.1% in British American Tobacco and 4% in Imperial Tobacco. He recently sold out of his position in tobacco firm Altria as it moved towards a spin-off of its Kraft food unit.
Woodford has also recently increased his utility holdings, adding to his holding in utility company International Power as well as oil majors BP and Royal Dutch Shell, which he believed were at attractive levels, following a decline in oil prices.
Talking about his current positions in British Energy and Drax, Woodford says he believes the idea that there will be cheap gas and cheap energy prices in the UK is a fallacy. "Instead, we will have to get used to much higher gas and electricity prices going forward, not least of course as a result of the carbon issue. I believe we are in an environment where energy prices will be higher for longer and as a result of that I believe British Energy and Drax both appear cheap at current levels," he notes.
With the fund currently positioned defensively, Woodford is not so much bearish on the UK environment but cautious, believing the market is in for a difficult time ahead. He says: "I believe it would be unrealistic to expect the sort of returns that we have seen in the past three or four years to continue into the future.
This is because there is more economic and market turbulence around - risks have risen because valuations have risen in some areas of the market, leverage has risen, asset prices around the world have risen - elements of excess are everywhere. I believe we are in for a more turbulent time, but I believe that may well be advantageous for some of the shares that we have in the portfolio. My view is that although returns will be lower, I do believe that the right portfolio will do well (high single-digit return) on a three to five-year time horizon."
Although Woodford believes the current and short term economic environment looks challenging, he has no intention of raising cash within the fund, preferring to remain fully invested. High Income currently features a negative position in cash at the moment, at -0.4%, which Woodford comments is a technicality, a by-product of the fund's large inflows.
He adds: "There are currently plenty of undervalued businesses in the UK market which I believe can outperform cash going forward, although my overall perspective is that some areas of the market are overvalued. Therefore, I believe one has to be very careful and very selective. My belief is that, with the right portfolio, we will outperform cash. To that end, we will remain relatively fully invested until that perspective changes."
Known for his consistency in style as well as his large, often contrarian bets on the market throughout the market ups and downs in recent years, Woodford has stuck with his own take on the markets, rather than following fashion. Sometimes this has been to his detriment, as was the case in the late 1990s, although in more recent years this has benefited investors in his fund.
Despite pressure in 1999, with his peers adopting a more capital growth stance to leverage the upward racing technology stocks and thereby boost the income on their portfolios, Woodford stuck to his style and did not take part in the race for growth despite the dwindling income environment as 'new economy' stocks overtook the popularity of the more staid, traditional income fund holdings. Of course this meant he was also protected somewhat when this market started to fall apart in March 2000, as value stocks rose to the fore.
His stance in what were considered more traditional income sectors, such as utilities, and more value oriented companies, helped support the fund when the dotcom and new economy stocks of the late 1990s collapsed. By concentrating on the ever-shrinking universe of companies that actually returned dividends to shareholders at a time when dividends were considered passé, Woodford may have missed out on the meteoric rise of technology but he underperformed only on a relative basis with High Income still generating returns during the run up in technology.
Woodford's High Income fund, which he has managed since 1988, making him one of the industry's longest serving fund managers on the same portfolio, has been a popular choice among intermediaries for more than a decade. International Investment's sister publication, Investment Week has reported that in a survey it conducted with leading intermediaries, the High Income fund comes out tops as the most popular fund since 1996. n
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