Neil Woodford October 2014:
As the father of four children, I am sometimes astounded at how quickly the mood in a room can change. One minute they’re all playing beautifully, collaborating and creating imaginative games together. The next minute, the room descends into chaos with shrieked accusations and threats of violence (not normally carried through, fortunately). Once things have calmed down, a parentally sponsored inquest will delve into the details of what actually happened but usually, it is impossible to fathom out exactly what caused the sudden change of sentiment.
And so it is with financial markets. One moment, all will be calm in the market, low volatility, bad news brushed aside, and major “big picture” issues will be ignored, deemed to be too distant or too improbable to care about. Suddenly and without warning, however, the chickens have a habit of coming home to roost, causing immediate alarm and sending short-term market participants heading for the exit in volatile conditions. Usually, the trigger for such a rapid change in sentiment is impossible to determine.
Christopher Wood, who writes CLSA’s Greed & Fear newsletter, observed last month, “When it comes to geo-political events, financial markets have the intelligence of a five-year-old (i.e. they only react when something ‘hits them in the face’).”
None of the factors suggested as potential causes of the stock market’s most recent retreat are new – the withdrawal of QE, slowdown / housing bubble bursting in China, valuation, geopolitical tensions in the middle east and Russia, Eurozone deflation to name a few. The articles on this website are evidence of that. Perhaps the worry list has grown a bit recently – the rapid spread of the Ebola virus, for instance or, more domestically, the political uncertainty that accompanies further devolution for Scotland. Nevertheless, the mood has changed and we wait to see how long the tantrum will last and how violent it will become.
The FTSE All Share Index declined by -2.8% in September in total return terms*. The CF Woodford Equity Income Fund has, thus far, withstood these volatile conditions resolutely as we had hoped it would, given our cautious views and strategy.
The fund received a “Bronze” rating from Morningstar OBSR during the month. This new rating joins the previously awarded ratings that we have received from FundCalibre (Elite fund rating) and Square Mile (AAA). Neil Woodford also holds a Financial Express “Alpha Manager” rating and an “A” fund manager rating from Citywire.
A number of stocks contributed positively to performance during the month. Amongst the larger holdings, the AA performed well, buoyed by half year results and a series of board appointments. Since its IPO in June, the shares have risen from 250p to end September at 322 1/2p per share. It is early days, but we are confident that the new management team can deliver on a clear long-term strategy of refining and strengthening the core roadside assistance business, as well as growing related businesses.
Reynolds American also performed well on no news. The shares have been grinding slowly higher since the sell-off that accompanied news of the Lorillard acquisition. We continue to view Reynolds American as a very high quality, undervalued asset and believe that the Lorillard deal looks very sensible and value-enhancing. Our holding in this US business benefited further from the strength of the US dollar during the period, a feature that we expect to endure.
Pharmaceuticals had a tougher month, with AstraZeneca in particular, displaying weakness as the US moved to try to close the loophole of “tax inversion” where US companies buy overseas companies as a way of reducing their US tax obligations. This short-term “will they / won’t they” speculation about Pfizer’ intentions towards AstraZeneca is an unwelcome distraction and we hope that, in time, the market can turn its attention back to the significant long-term potential that is building in AstraZeneca’s clinical pipeline. News on this front during the month was positive, with encouraging new data from its pipeline of potential cancer medicines being presented at the European Society of Medical Oncology (ESMO) 2014 Congress in Madrid.
Next also disappointed with an uncharacteristic warning towards the end of the month that, if the unseasonably warm weather were to continue throughout October, it may not meet current profit guidance. As long-term investors, however, we are not deterred by this weather-related blip and took the opportunity to add to our holding in what we continue to view as a very high quality, dependable retail business with an outstanding track record of delivering long-term shareholder value.
We added to several other core holdings during the month, including G4S and British American Tobacco on undeserved share price weakness. We also exited Reckitt Benckiser, a share which has been present in Neil’s portfolios for over a decade. We continue to view Reckitts as a great business with a very strong management team and an excellent product line-up. Such a high quality business deserves a high market rating but the shares have recently become too expensive to continue to justify their position in the portfolio.
As we have said before in these articles, one month (or even one year!) is too short a time period to be judging the success or otherwise of an investment strategy. Nevertheless, we are encouraged by the way the portfolio has behaved thus far and continue to believe that the portfolio is very well suited to these challenging market conditions which could persist for some time. Our longer term confidence in the portfolio’s ability to deliver attractively positive returns is undiminished.