Should you follow the crowd and buy the new Neil Woodford fund?

Marina Gerner
24 March 2017
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Celebrity fund manager Neil Woodford’s second income fund has opened its doors to investment and it is expected to prove popular with both do-it-yourself investors and financial advisers.

In light of this we have asked a couple of fund analysts for their thoughts on the fund to find out whether investors should in this instance follow the crowd.

But first a quick re-cap on the new fund will work and differ from Woodford two other funds – Woodford Equity Income (a Moneywise First 50 Fund), and Patient Capital

High starting yield 

The new Woodford Income Focus fund is aimed at those who want to draw an income and this is why it will aim to yield higher than rival UK income funds.

The fund will aim to deliver an income of 5p per share for every £1 invested at the end of its first full calendar year in 2018. This will equate to a yield of 5%. From then onwards Woodford will aim to deliver modest sustainable growth in per share income.

Most other UK equity income funds have yields within a range of 3.5% to 4.5%, while Woodford’s own CF Woodford Equity Income fund currently yields 3.7%.

The higher starting yield will no doubt attract the interest of the growing army of savers who are choosing to live off their investments at retirement and in effect pay themselves an income through the returns generated by their pension portfolio.

Unlike his other funds, this income fund won’t hold any of the unquoted, small and typically non-dividend paying growth companies the manager favours.

Instead, every stock will be a dividend-paying company, which limits the selection of stocks he can choose from. But the fund provides added flexibility in that he is free to invest outside the UK. The fund will be popular as Woodford’s track record speaks for itself.

Number-crunching by Hargreaves Lansdown worked out that across the manager’s 25-year plus career, he has produced an annualised total return of 12.7%, compared to a 9% return from the wider stock market (FTSE All Share).

But a high yield should be treated with a healthy dose of scepticism. Share prices and yields have an inverse relationship, so a high yield more often than not is a sign that a stock, for whatever reason, is out of favour.

Therefore the big danger when it comes to buying shares with high dividend yields is that investors can end up unwittingly buying a 'value trap' - a share that is in trouble and unlikely to keep its income promises.

 

Expert views

For those who don’t intend to draw an income from the fund, his existing Woodford Equity Income fund is likely to remain the better choice, argues Jason Hollands, managing director at Tilney Bestinvest.

He says: "While Mr Woodford has attracted a large following of investors and advisers who might be inclined to leap at the chance to invest in any fund he launches, there is little point to investors who are already significant holders of his existing Woodford Equity Income fund diving into the new fund as well, as there will be a relatively high degree of overlap in holdings."

He adds that for those who already have lots of exposure to funds managed by Neil Woodford, it might make sense to diversify elsewhere. 

According to Hollands, in the UK equity income space these funds include Evenlode Income, which is managed by Hugh Yarrow and Ben Peters. The managers share a few traits in common with Neil Woodford in that they also manage their fund from Oxfordshire, take a total return approach and are long-term buy-and-hold investors.

They run a concentrated portfolio of mostly large and medium-sized UK companies which the managers describe as ‘cash compounders’. These are businesses with strong free cash flow generation that are able to deliver high returns on capital and consequently grow their dividends in real terms.

They avoid businesses bogged down with lots of capital assets such as plant and machinery which can be costly to service and upgrade and ultimately drag on return.

The fund has almost a third invested in consumer goods business which includes Unilever whose vast array of brands includes Domestos, Hellman’s mayonnaise and Colman’s mustard, Marmite & Bovril, Persil and Surf washing powder, tea brands Lipton’s and PG Tips, and Ben & Jerry’s ice cream.

Although this is a UK equity fund, some 16% of the portfolio is currently invested in non-UK listed shares such as Microsoft, Johnson & Johnson and Proctor & Gamble.

Another alternative he recommends is Ardevora UK Income. Managed by former Liontrust duo Jeremy Lang and Bill Pattinson, who struck out on their own and founded boutique Ardevora in 2010, this fund has a distinctive approach that draws heavily on behavioural finance insights.

Hollands explains the team believes markets are "prone to bias from analysts, over confident company management teams taking too much risk and shareholders overreacting to short term vents, so they look to strip emotion out of their decision making – which includes not meeting company management teams - and seek to capitalise on the errors, anomalies and anxieties created by others."

The third alternative to Woodford’s new fund Hollands recommends is Standard Life UK Equity Income Unconstrained. Managed by Thomas Moore, this fund roams the UK stock market, with a sector unconstrained approach, to seek out companies with scope to grow their dividends.

It has much higher exposure to small and medium sized companies than bog standard UK income funds, with only 45% currently invested the FTSE 100. As such it had a tougher 2016 when large companies received a Brexit boost from the plummeting Pound, but the overall track record has been impressive. Top holdings include mining group Rio Tinto, investment bank Close Brothers and international payroll software firm Sage.

 

Sam Lees, head of research at fundexpert.co.uk echoes this sentiment, he says: "With any new launch, you must always ask the question: Why don’t I just buy proven alternatives?" As this fund is an income focused fund, Lees restates that consistent growth in income paid to investors is the vital component for income seekers.

He recommends the following two alternatives to Neil Woodford’s Income Focus fund. The first fund is, Schroder Income. The fund has a very good track record, growing payouts in 8 of the last 10 calendar years, including 2016 (+6%).

Lees explains the fund seeks out companies that are not correctly valued by investors (not just cheap but under-valued without good reason). "It doesn’t try to be too clever by timing currency strength or weakness. This is an approach that has served investors well."

The other fund he recommends as an alternative to Woodford is JOHCM UK Equity Income. This fund has also managed to grow its payouts in 8 of the last 10 years. Payout growth for 2016 (+8.6%) was helped by sterling  devaluation, says Lees. As with the Schroder fund this fund also has a value-bias and with more than most in small and medium sized companies.

While Woodford’s new fund certainly promises to be popular, these alternative fund suggestions can help investors diversify their portfolios further, especially if they have already a lot of exposure to funds managed by Neil Woodford.

This story was originally for our sister magazine, Money Observer.

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