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What investors need to learn from the Neil Woodford disaster

An investment with Neil Woodford, when he started out at Invesco Perpetual, would have turned £1,000 into £25,000 by the time he moved on to found his own Woodford Investment Management business 26 years later.

It’s easy to see why so many have, for so long, seen him as Britain’s answer to Warren Buffett. It’s too late now, obviously, for hindsight to help us avoid the subsequent catastrophe, but we can learn from it.

Strategy change

One thing that’s obvious now, and something Warren Buffett would never do, is that Woodford changed his strategy. Insiders are suggesting that one reason he moved on to his own fresh pastures is that while he was at Invesco, he was constrained in the investing directions he could take.

Many investors liked the resulting sound and safe strategy, and would have assumed the same approach would continue at Woodford Investment Management. I confess that I failed to see the significance of his change of direction, as it seemed quite subtle at the time.

I could see he was investing cash in startup growth prospects and unquoted equities, but I saw good blue-chip stalwarts too. I assumed that Neil Woodford was in a much better position than me to evaluate the blue-sky portion of his portfolio, and that it would be kept minimal.

Bailing out

But institutional investors got nervous, especially when one or two of his growth picks turned bad. Woodford was heavily into Purplebricks, for example, and that company’s share price crash reflected badly on his judgment.

By the time of the Equity Income Fund suspension in June, a lot of the smart money had already fled, and there just wasn’t enough liquidity remaining for those who were left to get their money out. The rest is now history, and there was little real surprise at least week’s news of the suspension of the remaining funds and the closure of Woodford Investment Management.

So yes, there’s one big lesson there for me, and it’s that when a respected investment manager changes strategy, especially after their old strategy had been so successful for so long, you need to react as though you’ve been poked with a very sharp stick.

A 26-year record as a safe investor in liquid and dividend-paying stocks says nothing about your chances of picking the best blue-sky growth prospects.

Conflict of interest

The fact that Woodford kept on charging for the dubious privilege of continuing to manage the Equity Income Fund while it was suspended highlights a lesson that I learned many years ago – that a fund manager’s loyalties are inevitably divided when he gets to take his cut regardless of how his customers’ money is performing. That’s why I’ve never voluntarily handed over any of my cash for anyone else to manage, and never will.

I’ll buy an investment trust, but with one of those I’m a direct part-owner and that reduces the conflict of interest. But even then, the decline of the Woodford Patient Capital trust shows there can be danger. So I treat investment trusts the same way as any other share, and I diversify.

And if you really must use actively managed funds, I’d strongly advise diversifying among those too – but I really do suggest checking out passive tracking funds first.

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Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.