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Out of the woods

Whether or not we decide to buy or sell a particular fund is not just down to its performance.

We go through a long and detailed process when we review a fund. This includes a review of both quantitative data and a qualitative assessment of the fund manager and their investment process.

One of our key points of focus is always the fund’s behaviour. Each fund has a particular job to do in a portfolio and so we are always asking whether the fund in question is doing that job properly. Funds also have to complement our other holdings

When we construct portfolios we divide the investment world into various categories based on asset class and risk. This extends not just to whether something is a fixed interest or an equity fund, but within equity which region the fund invests in and whether it is a more aggressive fund or a “steady Eddie.” We then decide how much we should invest in each category.

The CF Woodford Equity Income fund has been part of our UK Conservative Equity “bucket” for the last couple of years. This part of the portfolio is meant to exhibit lower volatility than the main UK market. Although we cannot predict or guarantee future returns, we would like the returns to be relatively consistent and, whilst we don’t expect the funds to outperform when markets are rising strongly, when markets drop they should fall less.

Typically such funds invest a large proportion in so-called “defensive” income producing stocks, usually those that make steady profits which are less sensitive to the economic outlook. Given current elevated market levels we have more of this type of equity at present than we do normally.

Our recent reviews of the Woodford fund have led us to believe that it may not provide the behaviour we are looking for in the future. In particular, Neil Woodford has sold out of some of the stalwart defensive stocks he has held for years such as some of the big pharmaceutical and tobacco firms.

In their place he has added things like housebuilders and financials, which are much more “cyclical” and generally do well only when the economy does well. Essentially, he is more bullish about the UK economy than many others and has adapted his portfolio accordingly.

The fund has also always had a small proportion in unlisted and early stage companies, particularly in the technology or bio-tech sectors. When we first invested with Woodford the fund was perhaps 90% in traditional income stocks and 10% in more growth areas such as this. We were comfortable with that split, but now those smaller companies make up a bigger proportion of the fund.

None of these things are necessarily a bad thing in itself. Neil Woodford has a long track record of making non-consensus calls and eventually being proved right. We are less bullish than he is about the UK economy but he could well be correct and if so the fund could perform well. However, we think this is beside the point.

In our view the fund is now a riskier proposition than when we purchased it. If the UK stockmarket falls, we think the fund is likely to fall as much if not more than the market. That is not the behaviour we want from this fund.

If the economy does well then the fund would probably outperform, however we already hold some more aggressive funds in the portfolio that we would expect to outperform in a rising market.

The fund has already been hit by some stock specific issues. For example, AstraZeneca fell 16% in a day last month, whilst Provident Financial fell around 70% in one day after a profit warning. Both of these were large holdings in the fund and the fund fell sharply as a result.

Despite this, we don’t think it is too late to sell the fund. We always have to assess what could happen in the future rather than looking backwards and the impact of such falls on the fund only merely illustrates the risk inherent in it at present.

We are currently in the process of switching away from the Woodford fund and into the Rathbone Income fund. Whilst we cannot predict future returns, this is a traditional income fund and we would expect it to be more defensive in a volatile market, whilst providing steady gains in positive markets. This is more the type of fund we would like to hold in current market conditions.

We still respect Neil Woodford and believe he is a good manager, it’s just we feel his fund is not the right one for our portfolios at the present.