Sunday, April 18

Neil Woodford’s back – but has he really learned anything?

All political lives, unless they are cut off in midstream at a happy juncture, end in failure – so said Enoch Powell. Is it the same for fund managers? Hedge fund manager Paul Marshall of Marshall Wace thinks so – and says so in his new book, 10.5 Lessons from Experience – but I’m not sure he’s right. If it’s a failure to more or less benchmark an index for 30 years and retire to the Home Counties with a lucrative defined-benefit pension long before you are 60, then, perhaps they have all failed. But most of us would be more likely to consider the nice pension and the pre-senility retirement to be a pretty good result. I suspect Marshall means not that all ordinary fund management lives end badly, but that all brilliant fund management ones do. It makes sense. As he says, if a manager does well, investors rush to their fund “making it increasingly challenging to deliver the same return per unit of risk”. When returns begin to fall as a result, “investors can vote with their feet, pushing the fund managers into forced liquidation and unleashing a negative spiral of poor performance and subsequent liquidation”.

Success leads to failure; nasty. But this isn’t the kind of thing that has to end a career. That, says Marshall, is more a matter of personality. Even the best fund managers will be wrong 45% or so of the time and will often have extended periods of underperformance. Experienced investors in their funds won’t necessarily be bothered by this (different styles outperform at different times) but, under intense “client pressure and peer pressure” the manager might start to be very bothered. The non-resilient often exit the industry at these “points of failure”. Other fund managers will go the other way – to hubris. “They extrapolate their own strong performance, build false confidence, begin to discard advice”, writes Marshall. Mistakes follow – often in the form of allowing funds to grow too big and individual positions to “grow to a size where they own you rather than you own them”. The successful don’t collapse when they do badly or preen when they do particularly well; they have the humility to know the market is playing with them. It’s almost as if Marshall had someone particular in mind when he wrote this, isn’t it? Why would anyone invest with Woodford This brings us to Neil Woodford, who announced in an interview with the Sunday Telegraph last weekend that he is on the comeback trail. Not even two years after the collapse of Woodford’s last investment management empire, he seems to be planning a new fund under a new company – to be called Woodford Capital Management (the last one was called Woodford Investment Management).

Fund management comebacks after periods of underperformance are far from impossible. All styles underperform – that’s why when we look at fund manager records we look at ten, five and three years, not six months. And it can often make really good sense to invest with or in someone who has failed before – get taken down by one lot of mistakes and you are unlikely to make them again. In the right hands, previous failure can almost be seen as an insurance policy against future failure. I’m not sure this is the case here. First, note that Woodford didn’t just make forgivable short-term stockpicking mistakes. He made pretty much every mistake possible in fund management: he took on too much money; he held overly large stakes in illiquid stocks; he sailed too close to the regulatory wind (encouraging companies to list in Guernsey to keep inside his own regulatory limits, for example). He mixed and changed investment styles – from value and income to small-cap growth); he believed and fuelled his own hype – his own website referred to him as “widely regarded as one of the finest investors of his generation”. His failure was not about poor performance. It was, as I said at the time, about a lousy mix of bad fund structuring, style drift, arrogance and inadequate risk management, a mix that caused his Equity Income Fund, once worth a ridiculous £10.2bn, to implode and investors to lose fortunes – around 25% of their capital if they went in at launch.