Star fund manager Neil Woodford has launched his Woodford Patient Capital Trust to great fanfare. But is the hype around the fund justified? And is ploughing cash into innovation the next big thing for investors seeking high returns?
There are few in the fund management world with a higher profile than Neil Woodford. During a 26-year career at Invesco Perpetual, his consistently high performance was the envy of his peers, as investors who trusted his track record ploughed their money into his funds.
In 2014 he set up his own firm, Woodford Investment Management, and launched his first fund, Woodford Equity Income. However his Patient Capital Trust, launched this spring, has seen him shift from his traditional largely blue-chip-oriented equity income sphere to the high-risk world of smaller companies and start-ups.
The message coming from Woodford Investment Management is that it"s by no means a leap in the dark, as for over a decade Neil Woodford"s equity income funds have been exposed to fledgling high-growth businesses - albeit in modest weightings.
Neil Mumford, Chartered Financial Planner with Milestone Wealth Management, agrees that Woodford is to some degree in familiar territory, and believes the new vehicle gives him greater flexibility. “It"s an interesting concept. Woodford has recognised that too many ideas and innovations end up going abroad because of the lack of investment and government support for some businesses. Over the years he"s been able to support some of those companies to a very small degree, but has been restricted by the mandates he"s been running. A vehicle like this means that he can invest without restriction - apart from capital issues.”
Justin Oliver, Deputy Chief Investment Officer at Canaccord Genuity Wealth Management in Guernsey, echoes this: “Neil Woodford has always had a tail of unquoted stocks in his portfolio, but Patient Capital allows him to indulge his passion and make start-ups and unquoted companies the main focus of the fund.”
Oliver is keen to point out that the composition of the fund means this is not a venture capital trust (VCT) by another name - a claim that has been made by more than one observer. “The fund portfolio will typically have 25 per cent in mid- and large-cap stocks with 25 per cent in newly quoted names. With half the fund in quoted and half in unquoted, this is clearly not a VCT.”
Patient Capital is set up as an investment trust listed on the LSE rather than an open-ended fund, and Mumford believes this structure was the logical choice. “A closed-ended vehicle is the perfect wrapper for this sort of investment because it will allow Woodford to invest without having to worry about redemptions. It"s likely to be popular and may well go to a premium, which is one of the factors that investors need to consider along with it going to a discount at times of under-performance.”
Mumford was interviewed prior to the launch of Patient Capital on the LSE, but his view was prescient. Woodford went on to raise £800 million, making Patient Capital the largest-ever UK-listed investment trust launch - and it indeed moved to a premium after making its debut. Investors clearly wanted a piece of the action, as the fund was oversubscribed.
Risk and return
Given the interest in the fund, it seems many retail investors will, through Patient Capital, be accessing non-listed start-ups, which they wouldn"t have the ability or knowledge to do otherwise. Oliver believes the Woodford name might well provide investors with a level of reassurance to invest in a higher-risk area that they"d ordinarily steer clear of. But he doesn"t necessarily think that"s a bad thing, so long as investors don"t invest all their money in the fund.
“Clearly there"s a higher risk with Patient Capital than with an equity income fund, so there"s an element of caveat emptor. But assuming you understand the risk level, this is a great opportunity to invest in exciting companies that otherwise wouldn"t get funding,” he explains.
Mumford takes a similar line: “Obviously it"s higher risk, but with potentially higher rewards. There are likely to be high swings in the value at times - Woodford isn"t immune to getting some calls wrong - but the trick is to get more calls right than wrong and the winners will more than outweigh the losers. Therefore investors should be aware that this is a long-term investment, which is why it"s called "Patient Capital".”
The fund will be diversified with a maximum of 100 holdings and no fewer than 40. It won"t invest more than 15 per cent in any single company and overseas holdings will never exceed 30 per cent of the overall portfolio. The manager isn"t hindered by any benchmark constraints so if he wants to strongly back a particular sector, he can.
Put simply, it"s a true stock-picking fund, with the planned return clearly defined. By investing in early-stage, high-growth companies, Patient Capital aims to generate returns of 10 per cent per year. If Woodford doesn"t beat this target then he gets no performance fees. If the target"s exceeded, then a performance fee of 15 per cent of the excess returns is paid, mostly in the form of shares in the trust rather than cash.
Martin Bamford, Chartered Financial Planner with Informed Choice, likes the way Woodford has set up the fund. “Not charging investors an annual management fee is an interesting innovation, and the hurdle rate for the performance fee looks sensible given the returns he"s targeting. So the trust scores well from a charging perspective.”
Oliver believes the performance fee is the real differentiator with this fund. “There are quite a few funds that invest in unquoted stocks, but Woodford"s pure performance fee and the fact that the fee is paid in shares rather than cash, makes this fund different. I think anything that aligns the interests of the investor with the fund manager is to be applauded.”
With crowdfunding increasing in popularity, is a "start-up fund" like Patient Capital a natural progression? And are we likely to see a more of these in the near future? Oliver believes more fund managers will follow suit, though without the Woodford brand he thinks investors may be wary of the credentials of some managers to deliver. He also believes that, despite Woodford"s experience of investing in start-ups, Patient Capital represents a new challenge for him, as small, unlisted high-growth companies are now the core elements of the fund rather than just a marginal presence.
“I think the fund is very interesting. Neil Woodford is a great fund manager and it could really take off,” says Oliver. “Of course it might be a different kettle of fish when he manages a portfolio with a high percentage of start-ups - only time will tell. We saw with Anthony Bolton at Fidelity, when he set up his China fund, that it doesn"t always work when star managers enter new territory.”
Treading carefully
While Oliver remains broadly optimistic about the fund"s potential, Bamford still has reservations. “I struggle to get too excited by news of the launch of this investment trust,” he says. “A lot of the focus I"ve seen to date is on the "attractive target returns" of 10 per cent a year, but little is mentioned about the levels of risk required to target returns of this magnitude. There is a clear link between risk and reward - in the current economic environment with low yields, you simply can"t target double-digit returns without exposing investor capital to high levels of risk.”
Bamford adds that as much as many investors and market commentators think of Neil Woodford as having magical skills when it comes to investing, he isn"t a magician. “He"s subject to the same laws and rules of investing as everyone else. So when he"s investing in early-stage and early-growth companies, it will mean exposing capital to high levels of volatility and the risk of capital loss. Only investors with the sufficient capacity to lose this portion of their portfolio should expose money to the trust.”
Patient Capital is certainly not a trade on/trade off investment, because it may take Woodford time to deploy the capital and time to get results. The portfolio will develop over 12 to 18 months, so initially it will invest in established mid- and large-cap stocks and steadily migrate into smaller listed companies and unquoted names as opportunities emerge.
The fund"s prospectus illustrates the type of innovation Woodford is keen to support. Gigaclear is one such operation - an unquoted business that builds and operates broadband networks in rural communities where larger scale telecoms businesses have no interest. Another company he name checks is Xeros, which has developed washing machines that use 80 per cent less water.
Oliver thinks other fund providers may be watching to see how Patient Capital fares before they introduce a similar offering to the market. He says that while investing in start-ups may not be new in and of itself, Woodford"s star profile might drive what has essentially been seen as a niche investment option to a more mainstream market.
However, he also argues that fund houses may find it difficult to replicate what Woodford is doing, notably on the performance fees. “Neil Woodford can afford to set up a performance fee that doesn"t earn him money in the beginning as he indulges his passion. However, other fund houses have bills to pay and I don"t think they"ll be able to offer the same fee structure.”
While initially the Woodford brand and the performance fee might attract investors, over the longer term the judgement call will be whether Woodford"s efforts to commercialise intellectual capital in the UK has converted risk into a satisfactory reward. We"ll have to wait and see.
This feature was published in the May/June issue of BL Magazine, which can be found here:
http://www.blglobal.co.uk/Magazines.aspx