Seven years ago, in 2014, the UK investment world suffered a seismic shock. Star fund manager Neil Woodford was leaving Invesco Perpetual to branch out on his own. At that time, Woodford was the UK’s #1 fund manager, likened to famed US billionaire Warren Buffett for his stock-picking skills. But going it alone was Woodford’s worst mistake.
Neil Woodford: star fund manager
Neil Woodford joined investment manager Perpetual (later Invesco Perpetual) in early 1988. Over the next 26 years, he became the UK’s most successful money manager. At his peak, he controlled as much as £33bn across up to six different funds. During his reign, £1,000 invested in the Invesco Perpetual High Income fund skyrocketed to be worth around £25,000. Woodford’s success came from buying mostly FTSE 100 stocks — typically companies with solid balance sheets, rising earnings, and fat dividends.
I will declare an interest here. From 1996/97 until around 2012/13, my wife was an investor in Neil Woodford’s flagship Invesco Perpetual High Income fund. Over this period, it was the best-performing UK equity fund by far. Thus, I was delighted with my advice to my wife to back Woodford.
Woodford Investment Management: downfall
In May 2014, Neil Woodford launched Woodford Investment Management (WIM), his own fund manager. Eager investors rushed to invest in the Woodford Equity Income (WEI) fund. In its first year, WEI gained 19.6%, triple the UK market’s return. Within three years, Woodford was managing £18bn. But then his star came crashing back to earth. Over the next two years, WEI became the worst-performing fund in its sector. With money flooding out from WEI through hefty withdrawals, WIM ‘gated’ (suspended) the fund on 4 June 2019, exactly two years ago today. Here are four lessons for all investors from Neil Woodford’s downfall.
Four lessons from Woodford’s failure
1) Stick to your strategy: Woodford made his name buying established, high-yielding dividend shares, and ‘value’ stocks. At WIM, he plunged headlong into start-ups, smaller companies, unlisted stocks, and private companies. Few of these go-go growth stocks paid any income, so Woodford was well out of his depth. Big mistake. As Warren Buffet says, “Never invest in anything you don’t understand”.
2) Higher returns mean higher risks: Woodford’s initial success at WIM came from buying big stakes in small companies. This juiced his returns in the early years. But these higher returns came with higher volatility and risk of loss. When these companies stumbled, so too did WEI. Thus, I avoid skewing my portfolio too much towards one company or sector. Instead, I spread my risk by diversifying widely.
3) Don’t fall into a liquidity trap: With many billions to invest, Woodford ended up putting way too much money into ever-smaller companies. His stakes in unlisted, unquoted, and private companies were extremely difficult to sell because of their lack of liquidity. Faced with selling shares in a hurry at steep discounts, Woodford was caught in a liquidity trap. This eventually led to his WEI fund being suspended two years ago today.
4) Beware of concentration risk: Chasing market-beating returns, Woodford bought large stakes in a select few companies. Frighteningly, WEI often owned more than a quarter (25%+) of some companies. Highly concentrated portfolios can produce bumper gains, but may also blow up spectacularly. That’s why I keep my portfolio highly diversified by spreading my eggs globally. It easier to sleep at night!
