Being a “bottom-up stock picker” has to be one of the most touted investment processes by fund managers.
However, according to star manager Neil Woodford – who is very much revered for his stock picks – this is useless without paying attention to the current and likely future macro environment.
Woodford’s long term track record is the envy of the fund management industry thanks in part to specific long term holdings in particular sectors such as tobacco and pharmaceuticals as well as avoiding popular but ultimately disastrous investments – such as technology stocks in the late 1990s during the “dotcom” bubble when others did the opposite.
According to FE Analytics, the former Invesco Perpetual manager has returned an average of 343.61 per cent across his various funds and trusts since 2000, meaning he has delivered more than three times the return of his peer group.
Performance of manager versus peer group over 15 years
Source: FE Analytics
Tobacco stocks in the FTSE All Share – BAT and Imperial Tobacco – have hugely outperformed the broader market over the longer term as the graph below shows demonstrating the importance these have played to his long term track record.
Performance of indices since 2006
Source: FE Analytics
The FE Alpha Manager(pictured), who heads up the £5.5bn CF Woodford Equity Income fund as well as the £800m Woodford Patient Capital IT, says while these bets have paid off he would not have succeeded without a long term macro forecast.
“I spend a lot of my time thinking about what is going on in the world economy as, of course, everyone knows that all businesses are to some extent effected by macro environment and what is happening around them whether its deflation, interest rates, tax, trade or social and political things that feed into the macro picture,” Woodford said.
“All of these things are important in helping me form a view about what is going to happen in the medium and long term. Trying to evaluate a business without having a macro view is in my mind, is like music without instruments - it just doesn't work.”
“If you focus on the medium and long term then you can make a better, more informed judgement about the macro environment. Of course that is only part of the picture. When you make investments you have to marry that macro perspective with your stock analysis and your valuation,” Woodford added.
He says all too often other fund managers ignore taking a macro viewpoint believing some companies can weather a potential storm, which he says is nearly always false and impedes making a realistic valuation of the company’s worth.
“Trying to form a view about valuation and where cash flow is going to be in the future without looking at the macro economy seems to me to be deliberately only looking at half the picture.”
“It is common sense. Every company that I have ever met would say that the performance of their business is affected by what they do and what they are able to control but also by the things that they don't control: the macro environment or competition etc.”
“I have virtually no interest, and no skill frankly, in being able to know what is going to happen in the short term. If you do the work then it becomes clear what is happening in the long term.”
He also says it is also very important to know when to sell, particular in a stock that has had a good run and re-rated several times.
“It is par for the course - all active fund managers will have sins of omission - and I learned long ago that maximisation was a false god in this industry.”
“What I set out to do is deliver an absolute return figure for my clients. I know there will be a portfolio out there, theoretically, that would do a lot better than that and many that will do worse but what I am trying to do is build a portfolio that does the job.”
“Portfolio construction is not a science. There is a lot of pseudo-science wrapped around which I am pretty critical of when I have the opportunity. I think lots of people hide behind pseudo-science. Actually portfolio construction and the whole investment management thing is more art than science, more judgement.”
He adds that it stills boils down to having a detailed but broad macro viewpoint.
“The most important thing is making judgements about the future. Trying to be scientific about the future is an inherently odd thing to do. The past is inherently important when making judgements about the future.”
“We are not trying to build a portfolio of great companies. We are trying to do is build a portfolio of great investments and those two are very different although sometimes they are the same.”
Woodford says his academic background in economics helped develop his process, although despite learning core economic theory and mathematical techniques - which he "hated" – he had a more profound understanding of how economies work when he started to work in fund management
“I am very interested in practical economics. I'd be very interested even if I wasn’t running money.”
Following more than 26 years as manager of the Invesco Perpetual High Income fund, Woodford launched his new CF Woodford Equity Income portfolio almost exactly a year ago. According to FE data, it has returned 19.2 per cent, more than doubling the IA UK Equity Income sector average and nearly tripling the returns of its FTSE All Share benchmark.
Performance of fund, sector and index since June 2014
Source: FE Analytics
He counts the likes of AstraZeneca, GlaxoSmithKline, Imperial Tobacco, British American Tobacco and BAE Systems as top 10 holdings, but has exposure to early stage business and unlisted companies further down his portfolio. It has a clean ongoing charges figure [OCF] of 0.75 per cent.
