Neil Woodford, who celebrated the £10.1bn fund’s three-year anniversary this month, also believes the vehicle could beat its targeted low double-digit annual returns over the next three to five years.
Broadly speaking, he said there is a wealth of opportunity in the market despite widespread fears that UK equities are overvalued, and expects large parts of his portfolio which have already performed well to achieve exponential total returns over the long term.
“I think there is quite a lot of opportunity in the market at the moment, which potentially sits uncomfortably with the view that the market is overvalued. I have some sympathy with this, because there are lots of large overvalued stocks,” the FE Alpha Manager explained.
“Many of the opportunities that I’m seeing in the market at the moment are focused around that domestic storyline. Without being too generic, the fact is that people are too bearish about the UK economy and that investors have reflected that bearishness in the underlying businesses that are exposed to the UK economy.
“I think that has created some interesting valuation anomalies and I’ve been taking advantage of that recently in the portfolios.”
Woodford said valuation is always the biggest driver when it comes to portfolio construction, although he was keen to point out that his investment decisions are never driven by the price he pays to invest in a certain company.
This process has stood CF Woodford Equity Income in good stead already as, since its launch, it has achieved the highest total return out of every fund in the IA UK All Companies sector with gains of 38.35 per cent. This is a respective outperformance of its average peer and FTSE All Share benchmark of 14.14 and 14.62 percentage points.
Performance of fund vs sector and benchmark since launch
Source: FE Analytics
“Valuation is independent of the price. Some stocks get cheaper as their share price goes up, some stocks get more expensive as their share price goes down,” the manager explained.
“When people talk about sell discipline they often make the mistake of saying ‘if the share prices gets to £2, then I’ll sell’. But, on the journey to £2 the company might become a better business, it might be cheaper at £2 than it was at £1. That’s why I have owned British American Tobacco for several years.
“The process is dynamic; fundamentals change, share prices change and valuations change.”
The area of the portfolio that he believes offers the most upside potential is its exposure to unquoted early-stage companies, which currently accounts for approximately 9 per cent of the fund.
“The unquoted exposure in the Woodford Equity Income fund is yet to kick in – one or two things have done spectacularly well but, when I think about that 9 per cent of the portfolio – albeit it has been a positive contributor to performance, I don’t think it’s even begun to do what it can do,” Woodford said.
“I could go down the list of things in the fund that I think are pregnant with potential. Broadly since we launched, I said the portfolio should be able to deliver high single-digit returns over three-to five-year periods per annum.
“What I have said more recently is I think the portfolio should be capable of delivering low double-digit returns over a three- to five-year period from where we are today.
“Where is the potential? I could go through each individual stock but the totality of that is I think there is a lot of upside.”
One stock he believes may not have shone out yet in the portfolio but is set to perform remarkably well over the long term is biotech firm Prothena, which the manager has held across portfolios for many years.
“Biotech businesses develop over a long period of time. Often you have to be very patient, particularly with drug development businesses,” Woodford continued. “What you do is you build confidence over a long period of time, so you work with the business and through the various development stages of the drug. As it goes from the pre-clinical stage, to the clinical stage and as it progresses through the various stages through to becoming a saleable drug.
“You build confidence in the business and you build confidence in the people that are steering that business. That’s what we’ve done with Prothena and I’m very excited about where that business is today.”
When it comes to listed holdings, the manager said AstraZeneca – which is the largest individual holding in CF Woodford Equity Income at 8.87 per cent – also offers some of the biggest potential upside within the portfolio.
Performance of stocks over 3yrs
The company has been in the news recently as eagerly investors await the results from its ‘Mystic’ immunotherapy trial, which will determine whether its new lung cancer drug is better at preventing cancer from worsening than chemotherapy.
“It has an incredibly important inflection point coming up in probably the next four weeks,” Woodford said.
“I think the market has slightly exaggerated the importance of Mystic but I’m very conscious of how important that trial is from a perception point of view. That would be another stock that I believe is on a journey to a much more profitable and more highly-valued future. There’s an important milestone on the way to that eventual outcome.”
While the manager is positive on the prospects for the fund’s dividend growth, there have been concerns that its most recent dividend pay-out is lower than its dividend payment one year before.
Woodford said he is very conscious of this, but points out that CF Woodford Equity Income is a total return fund with an income responsibility.
“We said we would deliver low-to-mid single-digit dividend growth and were able to do that in both years,” he reasoned.
“This year, I’m confident we’ll deliver towards the top end of that range. It is something our clients are very interested in – they want good total return and good income growth.
“Sometimes it’s hard to juggle all those things but we have delivered a very good total return since launch. We’re top in the sector over that three-year period.”
He added: “I’ve spoken about how I’m optimistic on what the fund can deliver over the next three to five years. What I would say is we’re equally very conscious of the income responsibility and, this year in particular, there’s plenty of potential to deliver towards the top end of that low to mid single-digit growth in dividend in calendar 2017.”
CF Woodford Equity Income has a clean ongoing charges figure (OCF) of 0.75 per cent and yields 2.89 per cent.