The recent stock market sell-off opened up a buying opportunity in several large cap stocks, which FE Alpha Manager Neil Woodford took advantage of. UK stocks fell from the start of September through to the middle of October as investors became increasingly jittery about weaker economic data in the US and the threat of deflation in Europe as well as the spectre of the spread of the Ebola virus and various geo-political tensions.
While a bounce back has arguably been seen over the past month, markets are still down from their pre-correction highs.
Performance of indices since 4 September 2014
Source: FE Analytics
The latest investment update for the £3.3bn CF Woodford Equity Income fund notes that a cautious position helped the portfolio over this period but delayed its bounce back compared to its peers.
Between 4 September and 16 October, the average fund in the IMA Equity Income sector fell 9.53 per cent but Woodford’s fund lost just 6.82 per cent. Since then it has risen 5.48 per cent, against the peer group’s 6.07 per cent.
“Although the UK stock market appears well underpinned, particularly at the lower levels briefly visited during the middle of the month, we remain cautious about valuations across many parts of the market, and anticipate further volatility in the near term,” said Mitchell Fraser-Jones, head of investment communications at Woodford Investment Management.
“The portfolio is positioned cautiously and performed as one might expect in such a volatile market – generally outperforming its benchmark as it declined during the first half of the month, but then tending to lag its recovery.”
Fraser-Jones says the fund’s holdings in tobacco, which make up 15 per cent of the fund, stood up to the sell-off with healthcare exposure also performing relatively healthily.
“Nevertheless, some stock specific disappointments did take the shine off performance for the month as a whole. In these volatile conditions, the market is in no mood for disappointment and any company that fails to meet earnings expectations is being punished brutally.”
In particular, he says Rolls-Royce fell sharply following a shock trading update in which it announced lower than expected earnings.
“Whilst the update from Rolls-Royce was unarguably disappointing, we were surprised to see the shares sell-off so aggressively. We took advantage of this by buying more shares. This is quite a normal reaction to disappointing news for our contrarian investment approach,” Fraser-Jones said.
“Clearly, our reaction to a profit warning will depend on the exact circumstances and the extent of the market’s reaction, but we do often find ourselves buying into short-term weakness.”
Fund manager Stephen Lamacraft, who left Invesco Perpetual to work with Woodford at the new firm, says the ethos of the team means often reacting in an opposite fashion to the market.
“The worst thing you can do is turn a disappointment into a disaster by reacting inappropriately. We often find ourselves reacting with a polar opposite response to the market on profit warnings,” Lamacraft said.
“As long as we can retain confidence in the fundamental long-term investment case, we will take any panic selling as an opportunity to capture more long-term upside potential.”
Fraser-Jones says pharma giant Sanofi also took a vicious hit during the sell-off following its third quarter results. While they met market expectations, the company worried investors with hints about its diabetes franchise, stimulating downgrades to earnings expectations for the next year.
“In retreating from €89.56 on 30 September 2014 to €73.66 by 31 October 2014, the entire value of Sanofi’s diabetes franchise appears to have been wiped from the market cap,” he explained.
“This seems somewhat harsh, particularly when one considers the diversity of Sanofi’s businesses, its pipeline of new potential products, its emerging market exposure which continues to grow strongly and its prodigious cash flow generation.”
“Admittedly, the departure of the company’s chief executive just after the results statement added a degree of near-term uncertainty, but we continue to view the shares as profoundly undervalued and took advantage of the share price weakness by adding to our holding.”
Sharp declines in BT and outsourcer Capita provided a buying opportunity for Woodford to add to existing positions, due to the market reacting impulsively.
“BT delivered interim results broadly in line with expectations towards the end of the month but its share price declined due to a slowdown of growth in consumer broadband subscriptions. Capita also saw a sharp and, in our view unjustified, fall in its share price as it failed to win any of the Probation Services outsourcing contracts recently tendered by the Department of Justice.”
Performance of stocks and index since 4 September
Source: FE Analytics
Woodford added one new position to his fund, engineering outsourcer Babcock International.
“We have been attracted to the business for some time and have been patiently waiting for an entry point. Over the course of this year, the shares have fallen from £13 in late February to trade as low as £10 briefly in the last few weeks, returning the shares to more attractive valuation territory,” Fraser-Jones said.
“As with most other UK outsourcing businesses, Babcock has a substantial forward order book, good earnings visibility through long-term contracts and looks well positioned to deliver sustainable long-term growth in shareholder returns.”
The manager also added four unquoted positions: early-stage healthcare firms Emba, Viamet and Stratified Medical, and semiconductor developer Spin Transfer Technologies.
This brings up the number of unquoted holdings in the portfolio to 10 companies, making up over 5 per cent of assets.
One of the largest macroeconomic themes contributing to the sell-off was a shift in quantitative easing (QE). The US brought its own QE programme to an end but Japan stepped in the next day to surprise with expansion of its money-printing stimulus.
The end of Fed QE has previously caused a spike in volatility in asset prices and expects and Woodford expects that could happen again in the near term. This has led him to aim to position the fund in a more defensive style although says the fund will still outperform over the longer term.
The fund has an ongoing charges figure of 0.75 per cent.