On a number of occasions, FE Trustnet readers have suggested there’s a much cheaper way of getting access to star managers.
Instead of buying a fund levying charges upwards of 1 per cent every year, it has been argued that investors would be better off copying a fund’s biggest holdings – especially those that have 50 and even 60 per cent in their top 10.
It’s interesting to note that among the highest profile and most successful investors of recent times are those with the majority of their assets invested in just a handful of companies.
Warren Buffett, and FE Alpha Managers Neil Woodford (pictured) and Nick Train are to name but a few of those who invest in this way.After all, if you think AstraZeneca is hugely undervalued and set for stellar long-term returns, why would you only hold 3 per cent in it? Why not 10 per cent? I thought I would put this theory to the test, and what better manager to look at than arguably the UK’s most respected investor Neil Woodford.
Using FE’s historical database, I looked at what returns an investor would have got if they’d invested in Woodford’s 10 largest companies between the end of August 2010 and when he left the firm in March 2014, compared to Invesco Perpetual High Income itself.
The 10 companies are weighted in the identical way as they were in the fund.
For example, AstraZeneca had a 9.8 per cent weighting at that point, and the 10 largest companies accounted for 53.6 per cent of assets. It therefore makes up 18.3 per cent of the “best ideas” portfolio.
The results are fascinating; initially investors would have been better off holding the manager’s best ideas than his fund, only for the outperformance to be wiped out over the last 18 months or so.
Performance of fund and “best ideas” portfolio Aug 2010 to Mar 2014
Source: FE Analytics
By the end, Invesco Perpetual High Income was 7.03 percentage points better off than the “best ideas” portfolio, inclusive of fees.
Initially the idea of copying the manager’s best ideas worked very well, with Woodford’s highest conviction ideas easily outstripping the returns of the fund.
However, the end of 2012 proved a turning point and Invesco Perpetual High Income has steamed ahead since then.
Source: FE Analytics
Why didn’t the process work? Woodford made some high profile buys and sells over the period, which benefitted the performance of his fund significantly.
Though he does have a far lower turnover than the majority of managers, he is susceptible to very big calls at certain times, which during his career have been justified more often than not.
The manager’s two biggest stocks – AstraZenca and GlaxoSmithKline – are still in the top 10 of his recently launched CF Woodford Equity Income portfolio.
However, he sold completely out of Tesco at the start of 2012, which was excellent timing; the stock has made double digit losses since then, compared to gains of 46.8 per cent from the FTSE All Share.
Performance of stocks and index Aug 2010 to Mar 2014
Source: FE Analytics
BG – another serial underperformer in recent years – has also fallen out of Woodford’s top 10, as has Vodafone.
The likes of Capita and BAE Systems have come in as replacements, which have both performed much more strongly.
The conclusion? First off what’s very clear is that Neil Woodford is a very good stockpicker and has added real value to his portfolio by chopping and changing his holdings.
Secondly, trying to replicate the performance of funds for a cut price only works if you’re willing to follow the movements of the manager in question; even the highest conviction manager can get it wrong, and you’ve got to be prepared to react to their changes.
This means keeping a close eye on monthly factsheets, and in Woodford’s case, newspaper headlines.
Only last week, Woodford – notoriously a long-term investor – sold out of HSBC a little more than a month after buying it for his CF Woodford Equity Income fund.
Very simply, things change – as the man himself pointed out in a recent article.
Constantly chopping and changing also means spending money on trading costs, which Woodford’s new offering currently absorbs into its 0.75 per cent charge.
“I can’t tell you the number of times I’ve done something alone the same lines – taking stocks ideas and keeping them for myself,” said Tim Cockerill, investment director at Rowan Dartington.
“I’ve followed stock ideas but no matter how adamant the manager is, on many occasions they don’t work very well. You’ve got to be very careful.”
Woodford is one of only a handful of managers that publishes his entire list of holdings.
The manager’s recently launched CF Woodford Equity Income fund has just over 50 per cent invested in the top 10. Investors may be tempted to invest in all of Woodford’s holdings, but from a practical point of view this would be almost impossible.
Moreover, a handful of the manager’s smallest holdings are unquoted, meaning that the average investor couldn’t get access to them even if they wanted to.
While the much smaller holdings don’t necessarily drive performance now, that doesn’t mean they won’t in the future, Cockerill says.
“If the market condition changes, then these satellite holdings could benefit the fund from a diversification point of view,” he explained.
“There could be a point when his smaller plays become bigger, and they drive performance. If you’re just invested in his top 10, you won’t get this kicker.”
“I can understand why investors might try and bypass the management fee, but at the end of the day, you’re getting a lot for you money. You’re not only getting Woodford’s decision making, but you’re getting the expertise of his whole team,” he added.
Cockerill says there is some merit in copying the best ideas of fund managers – particularly if it’s a high conviction idea for a number of stars. However, he says these should be used as satellite holdings rather than core holdings.
FE Trustnet will highlight some of the most popular off-benchmark positions with star managers in an upcoming article.
The first version of this article was published in Investazine. For more stories like this, click here.
