Woodford Closing Down and How to Avoid Dud Managers

No sooner had I suggested that Neil Woodford should retire after his management company was fired from looking after the Woodford Equity Income Fund (see my personal blog article here: https://tinyurl.com/yxflsh8c ) than he decided to shut down the company. So that looks like the end of his career as a fund manager. Other funds that the company managed were the Woodford Income Focus Fund which has also been closed to redemptions and the Woodford Patient Capital Trust (WPCT).

The latter trust’s share price fell another 5% today and it was already on a discount to Net Asset Value of over 45%. The board of WPCT needs to find another manager and quickly. But yesterday they said that “The Board is in advanced discussions in relation to the ongoing management of the Company’s portfolio and expects to be in a position to announce details of the new management arrangements shortly” so perhaps it won’t be long.

Is the discount on WPCT something to take advantage of? Or can one pick up some shares cheaply that the open-ended funds have been and will continue to dispose of? The problem with this is that valuing some of these holdings is exceedingly difficult and some that are unlisted may be worth a lot less than that at which they were last valued by the trust. In addition it may be some time before there are any realisations from the open-ended funds even in the liquid holdings. In essence it would need a lot of careful analysis by an investor to see if there is money to be made from this collapse, and I am not sure it would be worth the effort. Would anyone have any confidence in picking up shares in companies that Woodford had chosen? They might consider that a very negative indicator now.

There was an interesting analysis in the Daily Telegraph by “Questor” (Richard Evans) today on how to spot poor managers. One is not keeping to their initial promise about dividends from the fund, the second is not having a consistent investment style and sticking to it. He said that investment professionals “know perfectly well that no fund manager can offer certainty of returns but they can and do expect certainty about how their money is managed”. He also said they “have learnt the hard way that when they entrust money to an asset manager on the basis or track record or reputation alone, things go wrong”. I certainly agree with those sentiments.

Which is why I said yesterday that investors need to monitor their fund (or trust) investments closely. Unfortunately many of the people who invest in open-ended funds do so on the recommendation of others (IFAs or platforms) without understanding what they are buying. They often get very little information on the performance of the fund or the issues the manager is facing. Even if they do get sent it, they tend not to read it. This is something the FCA could look at to avoid such debacles in the future.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Burford, ShareSoc Seminar, Woodford Patient Capital and Patisserie

Burford Capital (BUR) have published a report by Professor Joshua Mitts over the alleged manipulation of their share price in early August, i.e. market abuse by “spoofing” and “layering”. It links it to the shorting attack by Muddy Waters and is fairly convincing.

They have also published a “witness statement” for an application in the High Court for disclosure of trading information from the London Stock Exchange so as to identify who was trading. In it they also appear to be suggesting that there may have been some “naked” short selling taking place, i.e. sales not covered by borrowed stock which they indicate is illegal under EU Short Selling Regulation 2012.

My opinion on the merits of Burford as an investment or who is going come out smelling of roses in this battle are unchanged – it could be neither. Incidentally I will be discussing the merits of Burford as an investment at some length in my presentation on my book “Business Perspective Investing” at the ShareSoc Birmingham Seminar tomorrow evening (Tuesday) – see https://tinyurl.com/yxryk2h2 . It’s not too late to register and it should be an interesting discussion.

Woodford Patient Capital (WPCT) issued their interim results this morning. Net asset value per share was down 26% on the previous year end. The share price removed unmoved but it was already at a discount of nearly 40% to the Net Asset Value and more write-downs in their portfolio have been made since the half year end. The discount is quite extreme for any investment trust. There have been more board changes and there is a lengthy article in the Financial Times this morning on the pressure faced by Neil Woodford to quit managing the trust. The article suggests the board has lost confidence in Mr Woodford and is courting other asset managers – but who would want to take it on?

I happened to visit a Patisserie Valerie café in York during my Northern vacation last week. Now under new management of course. But the service was absolutely dire, prices were high and there were few customers there when other cafes in the town were busy. One customer walked out because of the slow service. Looks like the new management have taken on a problem.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Paying Illegal Dividends, Burford Capital, Woodford Patient Capital Trust and Zero Carbon Objective

A group of investors including Sarasin, Legal & General, Hermes and the UK Shareholders Association (UKSA) has written to Sir Donald Brydon who is undertaking a review of the audit market. They have yet again raised the question of whether the International Financial Accounting Standards (IFRS) are consistent with UK company law. In particular they question whether profits are sometimes being recognised, thus allowing the payment of illegal dividends. The particular issue is whether profits can arise on certain transactions under IFRS from transactions between parent and subsidiary companies or by the use of “mark to market” accounting. The problem is “unrealised profits” that might turn into cash in the future, but may not.

This may appear a somewhat technical question, but it can in practice lead to over-optimistic reporting of profits, leading to excessive bonus payments to managers, and the general misleading of investors. Actually calculating when a dividend can be paid as dividends are not supposed to be paid out of capital is not easy and is not self-evident to investors. The published accounts do not make it obvious. Regular mistakes are made by companies requiring later “whitewash” resolutions to be passed by shareholders. The ICAEW has previously rejected complaints on this issue but it is surely an area that requires more examination.

Incidentally I was reading a book yesterday entitled “White Collar Crime in Modern England” (from 1845-1929) which is most enlightening on common frauds that arose when limited companies became popular – many of the frauds still persist. In the “railway mania” of the 1840s it was common to set up companies and raise the capital to build a railway when the chance of it operating profitably was low. To keep the share price high, and the directors in jobs, dividends were paid out of capital. To quote from the book: “unscrupulous directors could easily pay dividends out of capital undetected – projecting a false image of profitability and enticing further investment in their lines”. That was an era when auditors did not have to be accountants and were often simply the directors’ cronies. Standards and regulations have improved since then, but there are still problems in this area that need solving.

There was an interesting discussion on Twitter recently on Burford Capital (BUR) with regard to their accounting methods. Not that I am an expert on the company as I do not hold shares in it, it but as I understand it they recognise the likely future settlements from the litigation funding cases they take on. In other words, they estimate future cash flows based on projections of likely winning the case and the possible settlements. As I said on Twitter, lawyers will often tell you a case is winnable but they will also tell you the outcome of any legal case is uncertain.

It’s interesting to read what Burford say in their Annual Report under accounting policies where it spells it out: “Owing to the illiquid nature of these investments, the assessment of fair valuation is highly subjective and requires a number of significant and complex judgements to be made by management. The exit value will be determined for each investment by the contractual entitlement, the underlying risk profile of the litigation, a trial or an appellate outcome or other case events, any other agreements in respect of settlement discussions or negotiations as well as the credit risk associated with the investment value and any relevant secondary market activity”.

The auditors no doubt scrutinise the reasonableness of the estimates but any outside investor in the shares of the company will have great difficulty in doing so.

Neil Woodford’s Equity Income Fund has a big holding in Burford Capital. I commented on the Woodford Patient Capital Trust yesterday here: https://roliscon.blog/2019/06/11/woodford-patient-capital-trust-is-it-an-opportunity/ and suggested the Trust made a mistake in naming the Trust after him. It makes it more difficult to fire the manager for example. But the FT reported this morning that the Trust has indeed had conversations about doing just that. Woodford’s firm has a contract that only requires 3 months’ notice which is a good thing. At least they can keep the “Patient Capital” moniker because investors in this trust have already had to wait a long time for much return and it could take even longer to improve its performance under a new manager. But as Lex in the FT said, “patience is now in short supply” so far as investors are concerned.

Another major item of news yesterday was soon to be ex-Prime Minister May’s commitment to enshrine in law a target for net zero carbon emissions in the UK by 2050. This is surely a quite suicidal path for the UK to follow when most other major countries, including all the big polluters, will be very unlikely to follow suit. Even Chancellor Philip Hammond has said it will cost about £1 trillion. It will effectively make the UK completely uncompetitive in many products with production and jobs shifting to other countries. We might become the first really “de-industrialised” country which is not a lead that many will follow, and it will actually be practically very difficult to achieve if you bother to study what is required to achieve zero emissions. It will completely change the way we live with the transport network being a particular problem (trains, planes and road vehicles).

As I have said before, if we really want to cut air pollution and CO2 emissions, then we need to reduce the population as well as rely on such wheezes as electrification of the transport and energy systems. Mrs May’s last act as Prime Minister might be to commit the UK to economic suicide. It might not be a good time to invest in UK manufacturing companies.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Woodford Patient Capital Trust – Is it an Opportunity?

Neil Woodford’s problems at his Equity Income Fund which have caused the fund to close to redemptions have been filling up the pages of the financial press in the last few days. The fact that his reputation is now in tatters has spread like a contagion to others including to Hargreaves Lansdown (HL.) as they effectively recommended the fund (HL. share price is down 22% since May 16). It’s also affected the share prices of holdings in the fund portfolio as investors anticipate that he will have to dump some of his holdings in a fire sale to meet redemptions when the fund reopens.

Another company that has suffered is Woodford Patient Capital Trust (WPCT) which is an investment trust managed by the Woodford firm. It’s down 29% since mid-May and now trades at a discount to net asset value of 27% according to the AIC. That’s quite unusual for any investment trust who can typically control the discount by share buy-backs and other means. The shares are even being shorted by speculators according to a report in the FT which is again unusual for an investment trust. Is this a speculative buying opportunity I wondered? So I took a quick look at the company, and have read the last Annual Report (to December 2018).

This is an unusual trust in many ways. The company has an objective to deliver “a return in excess of 10 per cent per annum over the longer term”. That statement is a hostage to fortune if I ever saw one. It achieved a 6.9% increase in NAV last year, but is down over the last 3 years overall.

It has a peculiar management fee with a low base cost of 0.2% but a performance fee where the manager gets 15% of any excess returns over a 10% cumulative hurdle rate per annum, subject to a high watermark. That’s the kind of management fee that would put me off investing normally.

This is an interesting summary of the trust in the Annual Report: “WPCT has a unique portfolio of companies, developed over a long period, where the Portfolio Manager has a deep insight into the evolution of the businesses. Many of these companies are now in the commercialisation phase. For example, Proton Partners, the UK’s first high-energy proton beam therapy provider, treated 25 patients in its Cancer Centre in Newport last year and opened two further centres in Northumberland and Reading. Autolus successfully listed on NASDAQ and its CAR-T cell technology is in a strong position to drive advances in the battle against cancer. Meanwhile, one of the Company’s largest holdings, Industrial Heat, raised capital from external investors having shown positive progress and it is anticipating reaching a key milestone in the year ahead. Companies within the portfolio are also attracting high-calibre individuals, typified by the senior appointments at Immunocore.”

The trust consists of a portfolio of smaller companies, mainly unlisted but with some listed with a heavy emphasis on healthcare, financials and technology. The largest holdings given on the latest data sheet are Benevolent AI, Oxford Nanopore, Autolus, Atom Bank, Proton Partners, Industrial Heat, Immunocore A, Oxford Sciences Innovation, Industrial Heat A1 Pref and Mission Therapeutics. You only have to look at a few of these to realise that even where listed, the valuations might be problematic, and for unlisted ones that’s even more so. These are early stage companies in most cases.

It’s rather like a VCT portfolio except with even bigger bets on the longer-term prospects of the companies. Lots of comments about positive prospects, increasing promise and making operational milestones in the reviews in the Annual Report but little mention of profits. Page 19 tells you that 65% of the portfolio is unquoted, with 80% classed as “early stage” companies. The trust also employs gearing of up to 20%.

The Board of Directors looks experienced but they are also the typical “great and good” of the investment world, including one Dame, with lots of jobs – too many perhaps.

The trust issued a reassuring statement for investors yesterday. It said “The Board is pleased with the operational progress of its portfolio companies, which the Board believes continue to have the potential to deliver attractive returns, in line with the long-term mandate of the Company. The operational performance of these businesses is not impacted by recent events”. But it acknowledged the impact of events at the Woodford Equity Income Fund and on the share prices of investee companies.

I could spend days analysing the companies in the trust’s portfolio to see whether the valuations made any sense, and still be not much wiser about their real prospects. I am not sure it’s worth the effort. Does the trust have enough cash to undertake any large tender offer or share buy-back is probably more relevant and also meet the needs for more investment typically required by early stage companies? I doubt it.

Regrettably I think the name of Woodford on the trust could cause it to continue to trade at a deep discount even though there is clearly a team of people running the portfolio. It is never a good idea for a fund or trust to name themselves after the fund manager or his company, even if that was a major selling point when first launched.

Trust shares are always tradeable, at least unless a company asks for its shares to be suspended because of doubts about its finances. But the share price discount is driven by investor sentiment and I don’t think the view of this company among investors is going to be very positive for some time.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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