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Mark Dampier: Woodford remains unconvinced by UK recovery

The outgoing Invesco Perpetual Income and Higher Income manager remains unconvinced by UK economic recovery and the end of the banking crisis but positive on tobacco and pharma stocks.

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The biggest fund manager story of 2013 was the resignation of Neil Woodford from Invesco Perpetual. As you will be aware, Woodford is staying on in his post at Invesco Perpetual, and will continue to manage the Invesco Perpetual Income and High Income funds until he leaves at the end of April 2014.

Woodford’s imminent departure has been a big press story and unsurprisingly, much has been made of the amount of money leaving his funds. In fact, redemptions have been very low. Retail investors have remained loyal and a greater amount of money has left the Perpetual Income fund most simply because that is where the majority of the bigger institutional clients had invested. That said, it has done nothing to affect performance which has been good since his resignation date.

Much has been talked about the unquoted companies held in the portfolios, which amount only to around 5 per cent of each fund. Clearly, unquoted businesses tend to be more illiquid. Yet ironically, his resignation, if anything, has increased liquidity here. Woodford has in fact already received bids for unquoted and small-cap holdings he has in the portfolios. He is, however, extremely loyal to these companies and continues to believe they have much to offer. Indeed, RM2 International floated on the AIM market on Monday, and we can expect others to IPO in the coming months.

Turning to the economy, Neil Woodford finds himself bemused by how rapidly commentators have turned around from being doomsayers to euphoric speakers. After recently meeting Woodford, he highlighted what he believes is a veneer of a bullish economy, pushed by temporary factors he does not believe are sustainable.

First, an increase in consumer debt has helped increase consumption. Second, the PPI windfalls, which have been the equivalent of a huge tax cut, have also largely been spent. Finally, labour hoarding has flattened the employment figures. So overall, we have seen more consumption, more debt, more disinvesting and indeed, we have seen more public spending despite so-called austerity by the government.

There is also one other point that only one other expert (James Ferguson of Macro Strategy Partnership) has made to me. That is, the effects of QE2, which finished over a year ago, will now be largely diminishing – this will no longer help bank liquidity, yet we remain in the grips of a financial crisis. Banks are still deleveraging in both the UK and Europe. Woodford also does not rule out the possibility of a rerun of the euro zone crisis where the same old problems lie i.e. the banking crisis has largely been swept under the carpet by European politicians.

At the end of 2014 we will see liquidity tests for European banks. Yet all the steps taken by European politicians have actually increased the link between the banks and sovereign debt. Indeed, they have encouraged banks to buy more sovereign debt. According to Woodford, the problem has just been postponed.

Woodford, therefore, sees UK growth disappointing commentators this year. Having read the newspapers over the last two weeks, commentators have been euphoric in the UK economic revival – this consensus does leave me nervous too.

Turning to the market, recent market gains have come from a re-rating, rather than from genuine profit growth – something which other fund managers have told me. We will have to wait and see whether market gains throughout 2014 can be sustained.

Woodford now sees fewer undervalued stocks in the market, though he remains confident of his own portfolio. He admits the tobacco sector has had a poor year, yet he sees absolutely nothing wrong in these businesses and remains as committed as ever to the sector. He still sees plenty of value in pharmaceutical firms, both in the UK and Europe, and thus the portfolios have seen little change.

Finally, while we didn’t discuss it, I fully expect Neil Woodford to have a similar fund set up almost immediately after he leaves Invesco Perpetual. At that stage, investors will need to decide whether they move into Neil Woodford’s new fund or whether they stay with the heir apparent, Mark Barnett.

In fairness, he is no slouch at investment management, yet he will be taking on a significant challenge and running some very large funds. Nearer to the time I will return to this subject, particularly as I believe many investors will want to follow Mr Woodford.

Mark Dampier is head of research at Hargreaves Lansdown

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