The World economy is a difficult place – and according to veteran fund manager Neil Woodford things are going to get worse before they get better.
“I have been cautious for some time. The growth that policy makers pray for is a very long way off – and this is a problem for the world economy,” he said.
Woodford was speaking at a dinner to announce the launch of a new investment trust, the Woodford Patient Capital Trust, which will invest up to 75% small start-up companies – a mix of unquoted and quoted equities – with the remainder invested in larger undervalued companies.
It was dissatisfaction with the efforts of politicians that in part fuelled Woodford to set up a trust benefitting UK industry, as he believes there is not enough done to commercialise innovation in this country.
Looking at the wider macro backdrop, Woodford said that in particular developed economies faced secular stagnation thanks to ballooning debt levels.
“The US, UK and Europe followed Keynesian policy in an attempt to insulate their economies, but as a result it has created more debt and deflation,” said. “We have had a recession, but in trying to drag ourselves out of it we have created even more debt. I believe that in the future the response of policy makers will be seen as a fundamental error.”
The actions of the Federal Reserve, the Bank of England and the European Central Bank – namely to pump markets up with quantitative easing – has resulted in a distorted investment environment, in which Woodford says it is impossible to compare and contrast asset classes.
“Finnish sovereign bonds now have negative rates, Nestle has negative rates on its corporate bonds and Unilever is offering 0.5% on a seven year bond – these rates are telling one story, but equity prices are telling another,” he explained.
“If I had to bet on one being wrong I would say the equity prices are, and that we are due a major market correction. But I said that in 1999 and the stock market rallied for a further 18 months. When I think about the investment environment I would say it is as challenging as the economic environment. The risks are greater than they were three or four years ago, it is a very difficult situation for fund managers.”
Passive Funds Won’t Deliver
Woodford said that while there were opportunities, they were a lot harder to find and investors would have to accept that gains would be made against a backdrop of volatility.
“I am confident we can deliver, but it will be volatile. Investors are not very good at translating political risk – look at the political risk building in Europe, to assume that is not a volatility variable would be foolish.”
He also named China, the oil price and US policy failure as sources of potential volatility – and pointed to how stretched equity valuations had become.
Woodford expressed concerns that over the last five years while stock markets rallied investors had been lulled into a false sense of security.
“Monetary policy has lifted all boats, but indices are pregnant with risk,” he warned. “In the past, 'risk on, risk off' was the driver of performance, now it has to be about valuation. Equities are expensive; if you strip out miners, banks and oil majors from the FTSE 100 it is on a price/earnings ratio of 19 times.”
He pointed to the “ludicrous” valuations of Whitbread (WTB), Unilever (ULVR) and Reckitt Benckiser (RB.) as examples – the latter he has held for most of his career, but now deems it far too expensive.
“As a fund manager you have got to roll your sleeves up. There is not an abundant opportunity set, but this sort of environment will out the closet trackers and passive strategies will not do well – now is the time for an active manager to earn his fee.”
This article is part of Morningstar’s Guide to Investment Trusts, highlighting the benefits of these unique investment vehicles – busting the investment trust jargon, revealing potential pitfalls and celebrating those experienced managers who have earned the top ranking from Morningstar fund analysts.
