Neil Woodford: A fresh look at Patient Capital trust

He divides opinion after some poor performances, but is the market being too hard on Neil Woodford? Dzmitry Lipski takes a fresh look at the star manager's credentials.

Neil Woodford is one of the best-known asset managers in the UK, consistently delivering significant outperformance over more than 25 years career in fund management.

It's no surprise he has always been under intense media scrutiny, especially since he set up his own fund management firm in 2014 and launched Woodford Equity Income fund and later Woodford Patient Capital Trust. To support its investors, the firm went a step further in terms of openness and transparency among competitors by absorbing research costs and publishing all fund holdings on its website.

While the manager is more well-known for running large-cap, income-oriented funds, within the trust he purely focuses on disruptive early-stage and early-growth UK companies which, he believes, have significant growth potential over the longer term.

Given Woodford’s high profile and popularity among retail investors, the trust has raised in excess of £800 million from investors since its launch in April 2015 and has traded on a premium as high as 15%. 

However, despite its initial success, the trust has struggled relative to its peers in the AIC UK All Companies sector and the FTSE All Share. Since inception to the end of June, its shares lost 18.5% versus the FTSE All Share index's positive return of 24.2% and it is currently trading at a discount to its net asset value (NAV) in excess of 10%.

Source: Morningstar as at 31st July 2018         Past performance is not a guide to future performance

Source: Morningstar as at 31st July 2018            Past performance is not a guide to future performance

As with his open-ended fund, the trust's performance has been severely hit by several stock specific issues such as Northwest Biotherapeutics and Prothena Corp, combined with relatively poor sentiment towards UK smaller companies due to Brexit uncertainty. After a prolonged run of poor performance, the trust was dropped from the FTSE 250 index earlier this year.

While investors have been left disappointed about the recent trust performance, they should remember that every fund manager has stocks in his portfolio that can go through bad patches, and Woodford's picks are no different.

Source: Morningstar as at 31st July 2018           Past performance is not a guide to future performance

Investment case revisited

Eight months ago, we recommended the trust as our 'wild card' selection for 2018. The shares are currently little changed on the entry price but have been volatile, so now is a good time to revisit the investment case.

Of course, investors must be patient and fully understand risks that come with the Woodford approach and how the Patient Capital trust is built and managed. 

It's important to remember that this is a higher risk strategy as the manager invests in early stage disruptive growth companies, taking high conviction positions and holding them for the long term. As a result, the portfolio significantly differs from its peers in the sector and the index meaning its relative performance can diverge from the wider market over shorter timeframes.

This is a long-term investment opportunities strategy and, as such, the manager’s performance should be judged on returns over three to five years. Woodford has been running this strategy for just over three years, so still has time on his side.

Woodford has a history of successfully navigating through poor periods when his views and chosen stocks were out of favour for an extended period. For example, before the dot-com crash of 2000 and the financial crisis of 2008. 

The trust is relatively diversified in terms of number of holdings - 90 at the end of July, but very concentrated when it comes to individual positions, as the top 10 holdings account for 56.9% of NAV and, again, this is not unusual for a Woodford portfolio.

The five largest holdings currently are: Benevolent AI (9.8%), Autolus (8.4%), Oxford Nanopore (8.3%), Proton Partners (7.3%) and Immunocore (5.5%). Purplebricks is eighth at 3.5%. The manager can allocate up to 20% in any single stock making minor setback in portfolio performance a norm over short term.

Higher risk

Around 80% of the portfolio is in unquoted stocks which carry higher risk. While some are expected to fail, others could turn into future successful companies delivering exceptional long-term returns. A good example is online estate agent Purplebricks, which Woodford backed before its flotation in 2015 and has returned more than 250% to date.

At sector level, healthcare accounts for 54% of the portfolio, with the next largest sector exposures being financials at 19% and technology at 18%. The trust has no exposure to energy and mining stocks that were best performing sector in the market that didn’t help the trust's performance.

Geographically, the trust is UK focused with 76% allocation and the US accounting for 17%. The manager has no restrictions on overseas holdings. As these companies evolve, the geographical profile of the portfolio may also change to become more global in nature for reasons such as an overseas listing or as the result of changes to the capital value of a non-UK company.

The portfolio is biased towards more domestically focused stocks, reflecting the manager's belief that that the negative implications of Brexit for the UK economy have been overdone, with some sectors and stocks being deeply unpopular and trading at incredibly low valuations.  The economy has proved to be more resilient than expected and, in his view, is expected to surprise on the upside. 

The manager acknowledges that his strategy focusing on value and undervalued stocks, is proving to be unpopular now. Over the recent years the market has become almost detached from reality, completely insensitive to valuation and obsessed with momentum creating much wider dispersion in valuations between value and growth stocks.   

As valuations guide the manager's decision making for the long term, he would always be attracted to the undervalued stocks which currently happen to lag the broad market, an environment that might persist for some time. However, over the longer term, value sectors and stocks supported by improving economic fundamentals should find favour.  

Source: Morningstar as at 31st July 2018           Past performance is not a guide to future performance

It's also worth highlighting the trust's innovative fee structure, aligning both manager and investor. The trust does not levy any annual management fee, but instead charges a performance fee of 15% NAV returns above 10% per annum with high-water mark.

Given the weak NAV performance since inception, investors haven't been charged any fees by the manager yet. 

Overall, at current discount levels, the trust could be a potential bargain for investors with conviction in Woodford's stock picking abilities, providing exposure to innovative earlier-stage UK companies. 

However, investors must be able to tolerate the high risk associated with this strategy and be patient enough to wait for higher returns over the longer term.