Mark Dampier: Failing favourite still pleases me

The Analyst

The stock market rally since March has been dramatic, with the FTSE 100 increasing by 46 per cent. Plenty of funds have matched this increase and some that were heavily positioned in economically sensitive sectors have increased by over 70 per cent. But some funds that have not kept up with the market at all.

The most high-profile of these is Neil Woodford of Invesco Perpetual, who runs the extremely popular Income and High Income funds. He is one of my favourite fund managers but, given the size of the rally, it is perfectly reasonable for investors to ask why his funds haven't done so well.

To answer this question you need to know what drives Mr Woodford's stock selection, then you'll be better placed to judge whether you agree or disagree with his investment stance. It is often a mistake not to look at the detail behind a fund's performance – either good or bad.

Mr Woodford's investment process is a combination of looking at the global economic environment and then at what stocks he can buy to best reflect this view. It is fair to say that his economic views have not changed for quite some time; he has generally been bearish of the global economy on the basis that just about everyone has overextended themselves with credit. Too much debt can pose major risks to a business or economy just as it can to an individual, and we have felt the effects of that in the last couple of years.

The credit party ended suddenly and we have been left with the mother of all hangovers. The problems have yet to be properly addressed, indeed so far our Government's main solution has been to borrow a lot more money.

The banks are also under pressure from two contradictory requirements. The Government wants them to lend more to keep the wheels of the economy turning, but they also want the banks to retain cash and improve their capital positions. Clearly it is impossible to do both at the same time.

The economic recovery in the UK and US gives every sign of being slow and painful, so it is hard to believe we will return to a pre-credit crunch boom. We already know there will be tax rises, which were announced in the last budget and we can surely expect more bad news on this front after the general election. The opposition are warning us of tough times and we can expect severe cutbacks in the public sector. George Osborne's pledge to freeze public sector pay is just the beginning in my view.

In a slower growth environment the companies most likely to prosper are those which have strong balance sheets, are well financed (either with no debt or very manageable debt), and a stable business model that is relatively immune from problems in the economy.

To that end Mr Woodford has concentrated his portfolio around the companies that he feels best match this criteria. Two of his largest holdings are AstraZeneca and GlaxoSmith Kline, which are trading at levels that value them cheaply in comparison to companies that have participated in this rally so far. Other large holdings include Tesco, National Grid, Vodafone and British Gas.

Since March these stocks have been left behind as investors have anticipated a V-shaped economic recovery and bought more cyclical companies. Mr Woodford thinks this is highly dangerous and likens the situation to a similar one he faced in 1999/2000 when internet stocks took off and left the solid, dependable companies behind. He believes that his stocks hold tremendous value and that this will be recognised by the market, but of course he cannot say when.

So while Neil Woodford remains bearish on the economy, he is bullish on his own portfolio and I, for one, agree with him. It is also noticeable that he has actually raised the dividend on his funds this year while many other equity income funds have cut theirs by as much as 25 per cent. His funds may be at the bottom of the sector at the moment, but what this suggests to me is that investors should buy more of the fund and not sell down their holdings.

Mark Dampier is the head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more information about the funds included in this column, visit www.h-l.co.uk/independent

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