Too much pessimism has been priced into the UK market due to Brexit fears, according to star manager Neil Woodford (pictured), who believes the domestic economy will remain stable and predictable over the coming years. 
As such, he has added a number of domestic cyclical holdings to his £10bn CF Woodford Equity Income fund, including Lloyds Bank – which is the first time (other than a brief period holding HSBC) he has bought a banking stock in more than a decade.
While these purchases were partially funded through inflows, they were also bought into the portfolio at the expense of pharmaceutical giant GlaxoSmithKline, which Woodford has held across his portfolios for more than 15 years. He also trimmed his holding in British American Tobacco to make way for new positions.
“Since the Brexit vote last June, the market consensus has become increasingly cautious about the outlook for the UK economy. I think investors have become far too pessimistic about a number of things,” he said in his latest Woodford Equity Income investment update.
“First of all, the decline of the currency and its impact on inflation and, equally, the business and consumer confidence environment going forward up to the Brexit impact date in nearly two years’ time.
“I think the market has become too cautious about the rise in inflation and about broad economic activity in the UK. We’re at record levels of employment in the UK, job vacancies are at a record low. And of course, the one other very significant factor which I have been waiting for some time is that the credit environment has begun to normalise in the UK.”
A major beneficiary of this backdrop is UK banks, which have become increasingly popular among investors over recent months following heightened expectations for interest rate rises.
Performance of index over 1yr
Source: FE Analytics
Woodford says UK banks have broadly recovered since the crisis and will continue to rebuild their capital. Not only this, he says they are now lending to the UK economy – particularly to small- and medium-sized companies – which he argues is the first time since 2008 that credit has flowed into the economy at an acceptable price.
The manager decided to buy into Lloyds as he believes it is attractively-valued, well-managed and has a conservative balance sheet approach. He also believes it has the ability to sustain and grow its dividend over the long term.
Laith Khalaf, senior analyst at Hargreaves Lansdown, said: “The investment in Lloyds Bank is a bit of a milestone seeing as Neil Woodford hasn’t held banks in his portfolio since 2003, aside from a very brief flirtation with HSBC in 2014.
“Selling out of banks was one of the big calls Neil Woodford made which protected investors from the worst ravages of the financial crisis, and reaffirmed his reputation as an outstanding fund manager.
“Ten years after the onset of the credit crunch, Neil Woodford is now back in Lloyds, which reflects the fact that banks are finally returning to business as usual. Of the UK-listed big banks, Lloyds has made the most progress, and now looks like a safe stable bank with the potential to pay investors a handsome level of dividends.”
Woodford isn’t just bullish on banks, however. He says he is more positive on the UK domestic economy than many of his peers, which he explains has presented a number of interesting opportunities as prices of domestic cyclicals have fallen.
Alongside Lloyds, for instance, he has added new positions in Barratt Developments, Taylor Wimpey, Hansteen and student accommodation developer Watkin Jones, among others.
One new holding he believes is set to benefit from steady growth in the UK construction industry over the next few years is brick manufacturer Forterra.
Mitchell Fraser-Jones, head of investment communications at Woodford Investment Management, said: “The UK brick industry has been structurally challenged for many years, with surplus capacity. As a result, the domestic industry has consolidated and Forterra is one of the last remaining players with a solid market position and a low cost base.
“The weakness in sterling since last summer has meant that importing bricks from Europe is no longer as economic and the long-term prospects for Forterra now look very attractive.”
Other new holdings include Eurocell, Topps Tiles, British Land, London Metric, Card Factory and technology service company Softcat.
Woodford decided to finance these through the selling of long-term holding GlaxoSmithKline, which he says has been “frustrating” to invest in over the years given that three out of four of its business units – its consumer healthcare division, its vaccines division and its core pharmaceuticals arm – have consistently underperformed.
Performance of stock over 15yrs
Source: FE Analytics
“Over a holding period of more than fifteen years, I have consistently believed that GlaxoSmithKline was capable of delivering growth and realising shareholder value. Neither has been forthcoming to the extent that I had hoped and expected,” he explained. “Some investors remain hopeful of recovery but I am now less optimistic,” he noted.
Overall, the manager says it would be wrong to exaggerate the portfolio shift. While he points out that different managers will have opposing views on which stocks are domestic and cyclical, he says Woodford Equity Income now has an approximate 30 per cent exposure to this market area.
“Many of the things that our investors will be familiar with are still represented in the portfolio, a very significant exposure to healthcare for example, and significant exposure to overseas holdings,” he continued.
“It is the first time in a long time that you’ve seen a move of this type in the portfolio. But I have in the past been very exposed to domestic cyclicals and have had very big weightings in banks, not for a very long time, but I have had those sorts of exposures before.
“In many ways, this is a repeat of what the portfolio has looked like in periods gone by.”
Woodford says this is a reflection of his desire to capture more of the opportunity set he sees in the market right now, which he believes will stand the portfolio in good stead over the long term.
He concluded: “I see this positioning playing out over a number of years, largely because the backdrop to the UK economy I see as being pretty stable and predictable and pretty attractive, actually.”
Since the turn of the millennium, Woodford has comfortably doubled the performance of his peer group composite with an average return of 321.96 per cent.
Performance of fund vs sector and benchmark since 2000
Source: FE Analytics
Woodford Equity Income has a clean ongoing charges figure of 0.75 per cent and yields 2.94 per cent.