The Invesco High Income and Income funds, run by Neil Woodford protégé Mark Barnett, have been downgraded by Morningstar analysts to a Neutral rating.
Concerns about the fund’s high exposure to smaller and illiquid companies have sparked the change, as well “an increasing number of stock-selection issues” which have caused analysts to have a lower level of conviction in the fund.
Mark Barnett took over the running of the funds from Neil Woodford in 2014 and has maintained a similar investment style to his predecessor, taking a contrarian approach and backing out-of-favour stocks. But he has also inherited Woodford’s interest in small and micro-cap companies. By the end of September 2019, these businesses accounted for more than 30% of assets.
Morningstar analyst Peter Brunt says this was expected to an extent because Barnett has a more positive view on the UK economy than many other managers and therefore favours domestically focused stocks, which tend to be smaller. But it has also seen an increase in the number of early stage and less proven companies in the portfolio.
Brunt says: “Such a shift in market-cap profile for a strategy with sizeable assets has made the overall liquidity profile less attractive and has result in significant ownership of many smaller names. While the group has been able to meet redemptions so far, Barnett’s continued intent on investing in smaller names give us cause for concern.”
Indeed, Barnett has had to manage redemptions since his took over the running of the two funds five years ago, as many loyal Woodford investors followed the manager to his new investment house Woodford Investment Management, taking billions with them.
But, as performance has lagged in recent years, outflows have continued. The Invesco High Income fund has returned just 0.8% year to date, some 10.8% behind the average performance of a fund in the Morningstar UK Equity Income category. Over five years it has produced annualised returns of 2%, some 3.7% behind its category average.
When Barnett took over the High Income fund it had assets under management of £13.1 billion, today it sits at around £6.1 billion. The fund had been rated as Bronze by Morningstar analysts.
The Invesco Income fund has seen assets fall from £8.3 billion to £2.7 billion.
Such heavy redemptions are all too reminiscent of the recent Woodford debacle, where the toxic combination of poor performance, illiquid investments and investor redemptions led to the suspension of the fund and, ultimately, its closure.
Risks of Contrarian Investing
There are concerns that Barnett could suffer the same problems as Woodford, as redemptions from the fund increase the proportion of the smaller and less liquid holdings in the portfolio because they are more difficult to sell.
Brunt says: “The strategy has suffered from a high number of stock-specific problems. While contrarian investing often involves an element of risk, the nature of the some of the issues, including among small caps and micro-caps, has raised concerns over Barnett’s implementation of the approach.”
Indeed, concerns have also been raised in recent months about the amount of crossover between the portfolios of Barnett’s funds and those of Neil Woodford. One such example is litigation finance company Burford Capital, which saw its share price plunge after accusations were made against the company by a US hedge fund group earlier this year.
Barnett held almost 8% of the firm’s stock through the Invesco High Income fund, a further 2.8% through the Invesco Income fund and 2.1% through his Perpetual Income & Growth Trust (PLI).
Other names common between Invesco High Income and Woodford Equity Income include troubled doorstep lender Provident Financial (PFG), Oxford-based biotech company e-Therapeutics (ETX), and 4D Pharma (DDDD), whose shares tumbled this week after inconclusive data from a phase two study of its cancer drug.
Brunt says: “Barnett spent 18 years working alongside Neil Woodford, making him a natural successor for his funds … He has significantly increased the focus on small caps and micro-caps in the portfolio under his management, the research for many of which he is undertaking himself. We do not believe that this plays to his strengths, which we consider to be among larger and mid-size companies.”
Under the enhanced Morningstar Analyst Rating, a fund may have different ratings across its different share classes depending on their charges. While the Invesco fund’s clean share classes have been downgraded to Neutral, other more expensive share classes have been downgraded to a Negative rating. The ongoing charge for the clean share class is 0.92%, other share classes charge as much as 1.67%.
An Invesco spokesman said: "As an active manager, we continually evaluate holdings in the portfolio, seeking the best opportunities for our investors, based on where we have the highest conviction in risk and reward. The strategy of these funds has not changed."
Invesco said more than 80% of the funds were invested incompanies with a market-cap of at least £500 million.
