Education

Introduction

I suppose with Potter being my surname, one might think I had some magic in my genes – if you live in a fantasy world! I am grateful to J K Rowling for giving my surname to someone who isn’t a pompous buffoon of a retiree bank manager or an officious school caretaker (previous media Potters acted by wonderful British stalwarts). However, any foresight I can offer comes from experience and a decent understanding of human behaviour, not from Harry!

I certainly believe that if one has long experience of an area of human behaviour (and investments markets are classic models of that), then one can at least predict some probable outcomes.

Several years ago when Mr Neil Woodford left Invesco Perpetual to set up his own business, I declined to recommend his funds, even though I had supported him for literally decades in his previous role and my clients had been well rewarded. Shortly after he set up his own firm I was senior member of an investment committee at the firm I had merged my own business into and we discussed the Woodford offering.

A colleague was keen to use the funds – he had been getting a strong ‘sell’ from the sales ‘rep’ at the firm who was a long term acquaintance of his. Yes, fund managers have sales staff who use sales techniques on advisers, just like drug companies do with GPs. In both cases, there is legislation to prevent obvious corruption, but the fact that fund managers and drug companies pay fat salaries and bonuses to sales staff makes me think they must get results!

The committee, being a committee, compromised and agreed to put a small weighting of the Woodford funds in the firm’s model portfolios. My reservations were minuted, as I recall.

The future is not always a mystery

This week (June 2019) the main fund at Woodford Asset Management has been suspended for at least a short period and it may take a while before investors can make withdrawals. This is likely to upset a lot of people, especially investors at Hargreaves Lansdown, who kept the fund on their recommended list long after every one with any degree of skill detected possible problems. One can only speculate about why they did that and I have some pretty good ideas, but it is not for me to publish guesses, even if they are educated ones!

What were the problems I predicted years ago and how did I come to (correctly) anticipate them?

In essence the worry I had was that I knew Mr Woodford was a very strong minded character who did not tolerate contrary viewpoints. I had, like many advisers, been severely put down by him in meetings for asking questions that challenged his point of view.

I also knew that he liked being a major investor in smaller companies and in effect being involved like an executive director. This I knew from seeing an obscure documentary about his role years back in a company called British Biotech, which revealed that he was able to call the shots and act in ways that were in my opinion (as someone who originally qualified in UK company administration) bordering on the illegal.

So, I suggested that out on his own, he might act in a less constrained way. There would be no big risk management department at his new firm and no annoying compliance officer that he had no choice but to respect. Of course there would be appropriate processes, but a founding chief executive wields a lot of power (compare Metro Bank, Arcadia and others).

He was also attracting very large investment sums and for a man with an obvious level of confidence in his own ability, he might be inclined to follow some more ‘interesting’ investment opportunities – in effect play at a being a venture capitalist.

So my view was that Neil Woodford as the owner and outright controller of his own firm was a much more unpredictable character than he was as an important and well remunerated employee.

The question I asked myself and others was this: if a fund manager is highly respected, known to be very rich and exceptionally well paid, even something of a celebrity in his field, why would he take all the risks of running his own business?

There is only one answer – to have independence of action.

And what actions could he not take at Invesco Perpetual? Some became clear very quickly – a more transparent approach with better customer communication which everyone thought was admirable. However, this very transparency began to reveal some stock ownership that was at best out of the ordinary and in some cases hard to agree with. Once it became clear that his funds were holding large blocks of shares in unquoted companies – enough to breach regulatory limits, then serious alarm bells started to ring.

There is more that can be said about why the crisis has now been reached and if anyone is interested, I can offer more explanations on the telephone.

Right some of the time…

The lesson here is that fund managers of strong character are to be sought out and will make good money for investors in many cases, but we should never believe that someone who gets great results in one environment will in another. A strong character needs regulating at times!

I have previously written that I avoided the funds at Fundsmith for reasons to do with the manager’s over bearing personality. In that case, it looks like I made an overly cautious call – but if you own the Woodford Equity Income fund, you might be thinking ‘better safe than sorry’.