I once was chatting to an broadsheet financial journalist who told me that articles on only three topics make up the majority of their online readership - Buffett, Goldman Sachs and Gold. It is perhaps then little surprise that the piece I published on Friday about Warren Buffett's edge (or lack of) inspired a great amount of debate, not only on this site but also around the Web. It's extraordinary that we care so much about Buffett, when the evidence suggests that his best days might be decades behind him. Surely we should spend more time investigating who is or may be the Warren Buffett of today. It's on this note that we should take a closer look at Neil Woodford...
A great fund manager?
For those that don't know Woodford, he's had an esteemed career as a fund manager at Invesco Perpetual. As head of investments Woodford controls something like £20bn of assets there, the majority of which are invested in higher income stocks.
A quick look at his career history confirms that he's got a terrific record. In fact, it's generally believed that Woodford may be the finest fund manager in the country, and the ratings agencies fall over themselves to give him an A* - e.g. Citywire, and Trustnet. To put his performance in perspective, over the last decade he's returned a compounded 11.3% annualised return compared to the comparatively paltry 6.3% that Warren Buffett managed. Woodford has turned £100 into £290 for investors over a decade in a time when Omaha's finest only managed £185.
I've been tracking Woodford for some time, but have been recently reassessing his performance in the light of research from Societe Generale on 'Quality Income' stocks. For readers that are unfamiliar, their research highlights that dividend paying mid/large caps that display both high quality (in terms of their F-Score) and low bankruptcy risk have a tendency to significantly outperform the market.
As an investigation I decided to create a really dirty comparison of Woodford's record versus the different segments of the market that Soc Gen highlight. This is a really horrid comparison as actually the trustnet charts are quoted in GBP whereas the Soc Gen indexes are global and quoted in EUR but I've put this together merely to serve as a visual cue for discussion. We can see clearly that...
- The general equity markets have flatlined over 12 years causing no end of pain.
- High Yielding stocks have done much better than the overall equity market, generally doubling investors money.
- The 'Quality Income' segment of the equity market has done even better. Tripling investors money.
- Woodford's returns have also been exceptional, tripling investor's money with a notably high correlation with 'Quality Income'.
- Woodford's peer group appear to be really quite inept. Their performance fails even to keep up with the High Yield segment of the market.
Are you feeling lucky punk?
If you were picking an income fund manager in 2000, would you have had the smarts to have picked Woodford? Woodford was managing £2bn between 1999 and 2002 and according to interviews at the time was pessimistic on a recovery and more focused on the opportunities small and mid cap companies offered. But as the market rallied his success brought massive inflows into his funds forcing his hand to invest in much more liquid stocks. Could it be that his early success rather serendipitously gave him little option but to invest in the very segment of the market (Quality Income) that would perform best over the decade? He was quoted in a Moneyweek interview recently which highlights his current strategy:
"We continue to focus the portfolio on what we believe to be fundamentally cheap companies, many of which are termed as blue chip or the 'new sovereigns', and where we believe valuations continue to underestimate their ability to grow through a prolonged period of economic stagnation."
I do find myself reflecting on a passage from one of my favourite books - Nicholas Naseem Taleb's Fooled by Randomness. In it he compares the fund management community to a coin flipping contest where each of 10,000 fictional managers flips a coin annually, winning or losing $10k and keeping or losing their job. After 5 years there are 313 managers left (3.13%) having made money 5 years in a row 'out of pure luck'. "If we throw one of these traders into the real world we would get comments on his remarkable style, incisive mind and the influences that helped him achieve success".
Neil Woodford has managed to focus on the precise areas of the market that has performed best over the last decade. His peers have clearly, in aggregate, failed to grasp what he through skill and good fortune anticipated - that high quality income stocks would outperform. But given the additional constraints which managing £20bn or so brings can we expect Woodford's future performance to keep up with his past? There are clearly a huge number of investors betting 1.5% per year in fees that he can, in spite of the evidence suggesting that after huge inflows funds struggle to maintain their historic record.
A systematic Woodford portfolio?
I've just recently sparked some debate for suggesting that Warren Buffett's investment style could be mimicked as a systematic investment strategy, but here perhaps is another case in point. Woodford's style appears to be so closely correlated to those of Quality Income stocks that perhaps investors taking a punt on him might be well served by saving most of the 5% initial charge and 1.5% fee they pay a year to Invesco and choosing a cheaper and more systematic approach.
These days, using a high quality set of screening tools, it is relatively simple and inexpensive to build well diversified portfolios full of the kinds of low-volatilty, safe, profitable, dividend paying, cheap mid to large cap stocks that a Buffett or Woodford might choose. In fact our models of quality income strategies have had extraordinary returns over the last 12 months, putting many fund managers to shame. For those who don't fancy picking their own stocks there are an increasing number of excellent low cost options such as the Soc Gen Quality Income Index ETN which trades under the ticker SGQI. Just remember that past performance is no indication of future returns and for all I know the next decade may be kinder to small cap growth stocks.
The halo effect that surrounds heroes such as Buffett or Woodford can lead many to take leave of their senses. Just because someone has done well in the past is no indication they will in the future. Hindsight is a wonderful thing, but investing based on it blindly and without thought can be a recipe for pain. Perhaps it's better to learn from these great investors and put their insights to work for oneself at a fraction of the cost.
Filed Under: Income Investing,