Neil Woodford, manager of Invesco Perpetual high income, was in animated mood when I met him recently. It was good to see how passionate he still is about managing money and how strongly he feels about the present economic position. Some commentators call him Mr Gloom due to his often cautious view on the economy, although this is rather a simplification of his thoughts.
First and foremost, he is extremely bullish on the prospects for his own portfolio. More on that later. In addition, he continues to believe the legacy of the financial crisis will be around for many years to come. He suggests too many fund managers are seeing the world through “a conventional lens”, in other words, believing the usual economic rules apply. This has led them to favour more economically-sensitive stocks believing recovery is around the corner.
Mr Woodford believes they are failing to understand the bigger picture of the ongoing banking crisis. He maintains the environment has permanently changed and while policymakers are responding, they have a limited range of tools.
He sees no magic wand to make the West’s debt problems go away and does not expect a new stockmarket bull run – at least not one built on solid foundations. The European Central Bank’s long-term refinancing operation is, in his view “the starting gun for deleveraging”.
Mr Woodford believes the prime creditors, the banks, remain in trouble and there is even the possibility of nationalisation in some cases. He suspects they will have to do much more in due course, selling good loans while reducing lending and short-term finance to companies. In other words, bad debts have to be written off eventually and credit contraction is the inevitable result. He also points out around half of UK mortgages are interest only (that is, where no capital is being paid back), so it is worth asking how and when are banks such as Lloyds going to get their principal back? With a mortgage book of £360bn, Mr Woodford finds it troubling.
For these reasons, you will find no banks in his fund and his portfolio is very much shaped by his outlook. He wants to own companies that are well managed, have strong balance sheets, resilient business models and generate plenty of cash. His focus is on dividends and dividend growth and he believes companies with these characteristics can be found at attractive prices.
Activity in terms of buying and selling has been kept to a minimum recently. He sold Tesco when the recent profit warning came out and was able to dispose of the holding quickly. There was a big buyer in the market in the form of US investment guru Warren Buffett. Mr Woodford thinks Tesco simply have too many plates spinning and their competition has improved, making restructuring a more difficult task.
In contrast, he speaks enthusiastically about companies such as Drax, which he thinks will be one of the best renewable plays on the UK market. His well known stance on pharmaceuticals remains with big weightings in GlaxoSmithKline and AstraZeneca as well as overseas such as Roche and Novartis. His total pharmaceutical sector exposure is 30 per cent.
He also likes some manufacturing companies such as Rolls Royce, which he believes is considerably under-valued and easily the best company in civil aerospace. He says much the same about BAE, a business with excellent visibility of earnings. He thinks the proposed defence cuts will not harm BAE or Rolls Royce drastically, and their service books alone should give them plenty of recurring income.
Mr Woodford still thinks there is an arduous hard grind to come in the West, in the UK particularly, but he believes his portfolio will add plenty of value for investors. With a yield of around 4 per cent, plus plenty of potential dividend growth, I believe this is one of the very best defensive plays on the UK market available. There will probably be periods of underperformance in short term market rallies but I believe this fund will see you through the difficult times over the long term.
Mark Dampier is head of research at Hargreaves Lansdown