Class Is Temporary

A cautionary tale.

News this week that the artist formerly known as the Woodford Patient Capital Trust¹ appears to be circling the drain, with investors due to vote on whether they want to put the thing out of its misery early next year.

Quite.

For those of you that don’t know the Neil Woodford story, the executive summary is as follows.

In the early 2010’s Woodford was regarded as the best fund manager in Britain, due in no small part to his expert stewardship of investor funds through the Dot Com Crash and the Great Financial Crisis.

In 2014 he decided to leave Invesco Perpetual, where he had run a couple of fund mandates for 25 years, to set up his own shop - Woodford Investment Management.

Shortly afterwards, he launched several funds to great acclaim and much investor enthusiasm. One of which, the Woodford Patient Capital Trust (WPCT as the ticker used to be), was released into the wild in April 2015.

At this point, I was still in my first job. I can remember watching the price of WPCT on our market screen just after it launched and struggling to believe what I was seeing.

The shares were floated at 100p and none of the money raised had yet been invested - the fund portfolio was solely comprised of cash. The value per share was therefore, very obviously, 100p.

But that didn’t stop shares trading at 120p in the weeks following the float. Folks were so keen to chuck money at this bloke that they were essentially buying £1 of cash for £1.20. This was, of course, objectively mental.

Those same shares today are worth 9p.

Source: FE Analytics.

So what went wrong?

Well, the main issue is that Mr Woodford started to paint outside of the lines. His past success at Invesco Perpetual had been based on his ability to (seemingly) skilfully invest in very large, quite boring, UK businesses.

At his new shop, there was more of a focus on investing in small, nascent companies. The Woodford Patient Capital Trust was set up to provide a vehicle to hold these small cap “best ideas”.

Only, as you can tell from the above, it didn’t really work out that way. A number of the smaller companies that he backed went south and investors started pulling their funds.

This wasn’t so much of a problem when it came to WPCT. The investors in that fund knew (or should have known at least) what they were letting themselves in for. Investing in small, and in many cases private, companies involves risk and not just risk in terms of temporary drops in value, there is the potential for the permanent loss of capital - proper big boy risk.

However these early stage investments became more of an issue for Woodford’s flagship fund, the Woodford Equity Income fund.

This fund was regarded as the natural continuation of Mr Woodford’s old “dull and boring” Invesco Perpetual mandates. But there was a decent slug of small companies in there too, and this meant that a period of underperformance became the catalyst for a crisis.

When investors responded to poor performance by selling their stakes in the fund, Woodford would have to sell shares in the larger companies in the portfolio² to meet the redemptions. This subsequently meant that the allocation to small companies would rise.

Soon, the rising allocation to small companies within the portfolio became a reason to sell in and of itself - the fund was becoming something it was never meant to be. Further sales only made the problem even worse.

It became a tailspin that was impossible to get out of. The net result was that the Equity Income fund was suspended - and investors couldn’t get their cash out³.

The whole debacle led to a massive compensation claim, Woodford’s firm closing and Schroders receiving a Woodford Patient Capital Trust shaped “hospital pass” as they took over the management of the fund.

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So why am I telling you any of this?

It is certainly not to revel in Mr Woodford’s struggles. I’m sure he’s done very well for himself overall, and there was more than enough schadenfreude at the time from the usual suspects who spend their lives talking about doing things rather than actually doing things.

No, this cautionary tale reminds us that there is no such thing as a one way bet, particularly in a world with as many variables as the world of investment.

There will always be some bright shiny thing to catch the eye, particularly at a time like we are in now when everything is going up in a straight line. Honestly, at this stage, if aliens landed on earth I think it would be bullish.

Such bright shiny things will always be accompanied by a compelling narrative. And the narrative of a “star fund manager” who has the wit and skill to negotiate the capital markets on your behalf is a particularly compelling one.

But we are dealing with human beings here, and human beings are innovative and resourceful but they are also flawed.

Human beings get tired, they get hangovers, they get divorced. As was arguably the case with Mr Woodford, they also get ideas above their station.

No arena exposes such behavioural flaws quite like the capital markets.

I am, objectively, a horrible golfer. Woeful, a proper hacker.

But every once in a while, I can strike the ball in such a way that I get a pretty good outcome. No one who has seen me play golf however would be able to argue with a straight face that this is anything to do with skill. Rather, it is all to do with luck. No matter how much I might want to lie to myself in the aftermath.

Determining the cause of a certain outcome when investing is incredibly difficult, if not impossible. When we see a “star fund manager”, like Mr Woodford was in the early 2010’s, though it might be compelling to determine that his prior performance was due to skill numerous studies have shown that it is almost impossible to tell the difference between skill and luck when analysing a certain manager’s investment performance.

That is not to say that fund managers are all lazy imbeciles, far from it. They are (in my experience) seriously impressive cats.

However, there is an argument to make (as Robin Powell does in the article that I have linked to above) that the high level of diligence of fund managers makes the market as a whole even more difficult to beat, as the inputs determining share prices in the aggregate become ever better informed.

If the best, “mega brained” investors on the planet seem to stumble on outperformance like the rest of us would happen upon a tenner down the back of the sofa, then why should any of us spend our time chasing something so elusive?

You might think that reaching this conclusion would be fairly depressing for someone who spent thirteen years in the investment game trying to generate “outperformance” for their clients, but I think that it is just the opposite.

If we accept that chasing outperformance for it’s own sake is a fool’s errand, how much bandwidth does this open up in our minds to not only focus on what actually matters to our financial outcomes - but also, y’know, think about something other than finance?

Have a great weekend.

Nothing I write in these pages is ever intended to constitute advice to any specific individual. Past performance is not indicative of future returns.

1. Now catchily named the Schroder Capital Global Innovation fund.

2. Shares in small, private companies cannot be sold at the drop of a hat. This is one of the risks involved.

3. It is important to note that a fund being suspended does not equal a total loss of capital. It just means that units in the fund cannot be sold until either the fund is re-opened, or as was the case in this instance, the fund is wound up.

Investors in the Woodford Equity Income fund didn’t completely lose their shirt, it just took an age for them to get money back.