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The great bear

Invesco’s Perpetual’s Neil Woodford admits he has played defensively over the past three years and warns that fundamental economic problems remain yet he has still squeezed more than 20% from his income portfolio this year.

I do hope this doesn’t put the kiss of death on Neil Woodford but 2006 seems to have been yet another great year for him. His Invesco Perpetual income fund is up by 22.6 per cent in the year to date – over 1 per cent ahead of the next best performer in the sector, New Star UK strategic income.

What is perhaps more remarkable is that Woodford has been relatively bearish on the global economy and has therefore had a very strongly defensive portfolio over the last three years. This has not detracted from performance in any way, which perhaps gives you an indication of how cheap defensive stocks have been.

I caught up with him recently and he admitted that he has been too bearish over the last two or three years but feels that the fundamental problems are still there. The economic strength that we have seen over the last few years has hardly been balanced. Indeed, we are seeing ever increasing debt in the world economy.

It has been the US and China that have come up to the plate to deliver a boost to the world economy. Japan remains a laggard and Europe looks extremely fragile. Both the UK and US are still far too reliant on consumption-led growth, with the housing market at the centre of it all. This can have a secondary effect on asset quality, consumer confidence, consumer credit and unemployment.

The likelihood is that US rates will stay higher for longer than many people believe. We have a rooky Federal Reserve chief in Ben Bernanke who will be keen to establish a tough reputation.

None of this is new. Recent figures on the US housing market do not look good but many may argue that it is merely returning to normality from the extreme frothiness of the last two or three years. After all, we have seen slowdowns in Australia and the UK without disaster.

Woodford expects to see another rise in UK interest rates in the new year. The rises we have already seen are causing greater credit strain, which we can see in the rises in individual voluntary arrangements and bankruptcies. Woodford’s cautious investment style is therefore likely to continue for some time yet.

He sees many equities as being overvalued and points as evidence to the mid-cap index, with a trailing price/earnings ratio of 20 and a yield lower than the FTSE 100. Merger and acquisition activity has kept the market moving but he believes that many of the deals are expensive and far too highly leveraged.

Indeed, leveraging highly cyclical businesses is usually a recipe for disaster. Where he does like leverage is in such things as utilities where you have a more sustainable earnings’ model and where there is greater certainty. It is no surprise to see companies like Centrica and National Grid among his biggest holdings.

He remains keen on tobaccos, with Reynolds American being his biggest holding at 6.1 per cent and BAT at 4.5 per cent.

In fairness, some utilities have been reduced, particularly in the water sector. Scottish Power was sold from the fund following the sale of its US business.

Successes this year from the top 10 include Tate & Lyle and BT. The latter is an overlooked and forgotten stock – just the sort of area where Woodford likes to play.

Woodford may be bearish on elements of the economy but it is wrong to typecast him as a super-bear as others have done in the past. He is confident that the US will avoid recession in 2007 and in turn believes the UK will slow down rather than go into outright recession. Perhaps more important, he is a strong believer in his own portfolio, as he has been for all the years I have known him. He still believes he can produce absolute returns but perhaps would like to reduce investors’ expectations from the 20 per cent-plus returns they have seen. Mind you, he said the same to me at the beginning of this year too.

Another point is that (like me) he believes both commercial and residential property are overvalued. Indeed, he believes most asset classes are overvalued so a cash/equity portfolio is probably best, not the so-called diversified portfolios we hear about from many experts.

Mark Dampier is head of research at Hargreaves Lansdown


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