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19th April 2016

Neil Woodford: Making money despite an 'awful economy'

It's almost a year since the FTSE 100 reached it's all time high of 7,103.98. Having finally breached the glass-ceiling of 7,000, the UK stock market 'bottomed' at 5,500 in February this year following 10 months of falls from that peak.

It has since recovered somewhat to 6,377.47 today, but volatility is likely to continue, according to Neil Woodford, manager of Elite Rated Woodford Equity Income.

“There is a lot to be worried about,” he said at a conference hosted by Jupiter last week. “Markets are challenged and highly valued. Growth is low and the world in general has numerous political and economic challenges. Central bankers seem ill-equipped to deal with the situation.”

“In the UK, the situation isn’t any better than anywhere else. It’s hard to be positive when the economy looks so awful! But there are pockets of opportunity. For me, it’s in the early-stage businesses where the demand for investment capital is high but supply is non-existent. That’s where I can make some money.

“Science is something the UK does very well and we have world-leading universities in this field. But we are very bad at turning great science, into great business. If we want to succeed in the future, we need to put more behind our young people and back their ideas. Otherwise our economy is doomed.”

Neil was guest speaker along with Terry Smith, manager of Elite Rated Fundsmith Equity; James Findlay, CEO of Findlay Park Partners; James Hanbury, partner, Odey Asset Management; and John Chatfeild-Roberts, head of the Jupiter Independent Funds Team, which manages three Elite Rated Merlin funds.

Quantitative easing is the problem, not the solution

Terry Smith was equally damning about central bank policy: “My view on quantitative easing (QE) has, for some time, been that it isn’t the solution, it’s the problem. The distortion in the apparent cost of funding has led to bad decisions and bad allocation of resources. But when they [central bankers] see QE isn’t working, they are just assuming that if they do more, it eventually will work.”

Valuations matter less over time

“I have a three step process,” continued Smith. “1) Try to only buy shares in good companies; 2) Try not to overpay for those shares; and 3) Do nothing! Let your companies perform.

“The first part might sound obvious, but not all managers are trying to buy good companies! The second part is important, but less so than actually finding a good business in my book. In the long term, it doesn’t matter so much.

“So as quantitative easing has pushed up markets and made companies more expensive, I’ve just adjusted my ‘set’. Valuations are still comparative, you just have a different yard stick. You have to find 'enough' value and believe that the company will grow faster than the average.”

Brexit – nothing to see here!

Brexit is the buzz word at the moment and no day goes by without the subject coming up. This event was no different and the panel were asked if they are adjusting their portfolios in anyway. John

Chatfeild-Roberts kicked off the response by saying: “It's such a binary issue it’s difficult to do anything until we know the result. You simply can’t base a strategy on what ‘might’ happen.

Smith agreed. “I’m not doing anything either,” he said. “Helped by the fact that I manage a global portfolio, obviously, but I’ve asked the management of companies in which I invest and few are worried.

According to Woodford, his company carried out some analysis on the situation and concluded that, leave or remain, there would not be a significant long-term difference to the performance of the UK economy.

James Hanbury said that he had made a few small changes at the margin, but was more concerned about the impact on our currency. “I think the impact on sterling is more relevant and it could weaken as far as $1.25 against the US dollar. But long term, it has a diminuous impact on the economy. The FTSE 100 is very international. The FTSE 250 might be hit harder in the short term.”

“I’m more worried about Donald Trump,” said James Findlay, who is a US equity manager.

Banks: a policy tool or an investment?

The panel were more split on the subject of banks, when Chatfeild-Roberts questioned them as to whether they are a policy tool or an investment.

James Findlay commented: “In the downturn in 2008/2009, banks were very cheap and there were actually some good opportunities. Now many are just still over-earning on credit and under-earning on savings, so at this stage of the cycle, I’ve reduced my holdings to two high quality banks only.

“At the back of mind is always the thought that there are financial weapons of mass destruction. All you need is someone, somewhere, doing something you don’t understand and there are huge ripple effects as we saw with the great financial crisis.”

James Hanbury too owns a couple of banks. “I own two ‘safe’ banks if you can call them that, but have steered clear of retail banks as I think they are a crowded trade. I’ve also got one Greek bank called ‘Alpha’. It’s a small position, as there is quite a lot of risk, but the rewards could be good too.”

Woodford and Smith were more wary. “I had a brief flirtation with a single bank a couple of years ago,” said Woodford. “It was my first since the 1990s and wasn’t long-lived. I just don’t know how they work. Royal Bank recently released a 550 page report on their business. It’s too much. I’m not saying all banks are bad, just virtually impossible to understand. And there are better places to invest in my view.”

Smith, who was a bank analyst in the 1980s and famously wrote a sell note on Barclays – his employer of the time – concluded: “It used to be much easier [to understand banks]. You could look at the accounts and exposure and have a view. They took deposits, lent money and retained a loan book. That’s what a bank should be.”

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The manager's views are their own and do not constitute financial advice.

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