Equity markets are “remarkably complacent” about global economic trends such as an aging population and a growth slowdown across the board, according to Neil Woodford.
The star manager, who runs the CF Woodford Equity Income fund and the Woodford Patient Capital trust, also says that markets are continuing to react sensibly to the EU referendum result despite some irrational sector movements.
Performance of FTSE 100 over 1month
Source: FE Analytics
Over the last month, the FTSE 100 has returned 4.25 per cent and is up 13.5 per cent since Brexit was announced while, since the start of the year to the day of the referendum, it returned just 3.86 per cent. 
While Woodford (pictured) says that this trend is encouraging, he warns that potential headwinds in the market are at risk of being overlooked.
“The UK market continued its post-referendum recovery in July, having quickly concluded that the UK’s vote to leave the European Union is not as big a deal for the economy or stock market as initially feared,” he said.
“Nevertheless, equity markets remain remarkably complacent about some of the bigger issues facing the global economy. Debt, ageing demographics, deflation and a disturbing lack of productivity growth are among the factors that have been worrying us for some time and that the bond market appears to be pricing in more appropriately.”
That said, the manager says that the market’s strong performance has bolstered the performance of the £9.5bn Woodford Equity Income fund over July, as it returned 6.85 per cent compared to the FTSE All Share’s return of 4.01 per cent and its sector average’s return of 5.79 per cent.
Performance of fund vs sector and benchmark in July
Source: FE Analytics
Woodford says that financial services blue-chips Legal & General and Provident Financial, which are the fifth and sixth-largest positions in his 121-stock portfolio respectively, achieved strong returns throughout July despite a shaky start to the month.
Since the start of July, Legal & General has returned 11.4 per cent while Provident Financial has returned 18.16 per cent.
“Both of these stocks were helped by a calmer market which has started to value their healthy, cash-generative revenue streams more appropriately. We remain very attracted to both businesses believing that the market still fails to value their long-term growth prospects,” the manager explained.
However, he argues that certain areas of the market performed irrationally over July, with large tobacco stocks such as Imperial Brands and Reynolds American struggling through the month despite a period of strong performance in June.
Imperial Brands for instance, which accounts for 8.16 per cent of Woodford’s entire portfolio, retraced some of its gains and returned just 0.68 per cent last month and, year-to-date, a sideways and choppy performance has led to a 0.49 per cent return.
Performance of stock in 2016
Source: FE Analytics
“There was a distinct difference between the fortunes of our large pharmaceutical and tobacco stocks [in July],” Woodford continued.
“This performance disparity is difficult to explain and is not linked to any deterioration in fundamentals. We remain attracted to all of our exposures in these sectors.”
The stock that gave the biggest boost to Woodford Equity Income’s performance was US Biotech firm Prothena. The manager says that it released positive trial data for its potential treatment for AL amyloidosis at the start of the month which led to a significant improvement in investor sentiment.
“The market’s response was initially muted but it has started to warm to the importance of this news, with Prothena’s share price rising by over 50 per cent by month end,” he said.
“In our view, this new data significantly derisks the registration trial for the drug, which is due to read out towards the end of 2017 or early 2018. We met management during the month for a full update on the company’s pipeline development progress.”
“We remain convinced that the current share price is profoundly undervaluing Prothena’s long-term potential, not just in NEOD001, but also in the Parkinson’s disease therapy that it is developing in partnership with Roche and in other earlier-stage but very promising drug development candidates.”
In terms of how the portfolio’s positioning has changed, Woodford added to Legal & General, Provident Financial, Babcock, Capita and BCA Marketplace as their share prices became distressed immediately after the referendum result.
He also bought into research institute Metalysis in July, which is a new position in within Woodford Equity Income but has been an unquoted position in Woodford Patient Capital since February this year.
“The above additions were funded by further trimming the positions in Reynolds American and Roche. We also disposed of the position in BAE Systems,” the manager explained.
“In similar circumstances to the recent decision to sell BT, not a lot has changed at BAE. Like BT, it has a substantial pension deficit which is something of a concern in this environment of ultra-low interest rates.”
“Nevertheless, its yield remains an attraction but with only modest growth in the dividend expected over the next few years, it is no longer as appealing as other businesses in which we have increasing confidence in a more compellingly attractive total return.”
Woodford says that the aforementioned Provident Financial holding is likely to offer far more attractive returns than BAE Systems as we head throughout the year as he rates the management team highly, he knows the business well and the firm’s ability to both manage and deliver investors’ expectations impresses him.
He points out that, given its starting yield is 4.6 per cent and it is expected to grow by 15.9 per cent per year, it could potentially return 20.5 per cent per annum.
“Provident Financial isn’t the only example – the vast majority of the portfolio’s assets are invested in stocks with attractive dividends and good sustainable dividend growth prospects,” he continued.
“It is this, alongside the long-term upside that exists in smaller positions in earlier-stage businesses as they progress towards commercialisation, which gives us tremendous confidence in the portfolio’s ability to deliver high single-digit annualised returns to investors over the long term.”
Since Woodford Equity Income’s launch in 2014, it has returned 31.03 per cent, more than doubling the performances of its sector average and benchmark.
Performance of fund vs sector and benchmark since launch
Source: FE Analytics
Over the same time frame, it is in the top quartile for its Sharpe ratio (which measures risk-adjusted returns) and maximum drawdown (which measures the most potential money lost if bought and sold at the worst times) and is in the third quartile for its annualised volatility.
