Rumours of the reasoning for the star manager’s departure have been rife, centred around a cryptic turn of phrase he used in his resignation statement. "My decision to leave is a personal one based on my views about where I see long-term opportunities in the fund management industry," he said.
Presumably, this suggests that Woodford (pictured) doesn’t believe his stable of funds is best placed to take advantage of "the long-term opportunities" driving investment returns in the future.
Details of his new fund management business are non-existent at this stage, but the vast majority of experts I have spoken to say they expect him to go down a different route.
"I’d be amazed if he started running other UK Equity Income funds," FE Alpha Manager Bill Mott told me.
What does this say about UK Equity Income funds, and especially those – like Invesco Perpetual High Income and Income – that focus on quality large cap defensive companies that pay out a healthy dividend?
These kinds of products have become staples with UK investors in the last decade, with multi-billion portfolios such as Artemis Income and Threadneedle UK Equity Income joining Invesco at the top of the inflows tables year after year. If Woodford thinks there are opportunities elsewhere, is it also time for investors to jump ship?
Analyst at FE Research Charles Younes (pictured) believes that Woodford’s decision to leave could be reflective of the increasing stress levels in the UK Equity Income market. He argues that it is becoming more and more difficult for managers to add value when investing in UK large caps, which may have prompted Woodford to look elsewhere. "I wasn’t all that surprised when I found out he was leaving to be honest – if you’d told me two or three months ago that Neil Woodford was leaving Invesco Perpetual, I would have believed you," he said.
"For a long period now I’ve been concerned about UK Equity Income. If you look at the large cap dividend payers, they’re sitting on huge heaps of cash and they’re not using it."
"There’s very limited growth coming out of them, and though they can pay out a special dividend now and again, unless they put that cash to work they’re not going to give investors much in the way of returns."
"Dividend cover and yield is one thing, but if you’ve got no growth, it becomes very difficult to add any value."
Younes points to James Henderson’s decision to move his Henderson UK Equity Income fund from the IMA UK Equity Income sector to the IMA UK All Companies sector as evidence of a manager who has become frustrated with this issue.
"Henderson doesn’t want to be constrained by a yield target, because with companies sitting on all that cash, it means he can’t get any growth into his portfolio," he said.
"He’s turned around and said: 'I don’t care about yield any more, because I want to give my clients the best chance of making good money'. He might still hold some companies with a yield, but it’s no longer a priority."
Henderson UK Equity Income has flourished without its yield constraints of late, boasting top quartile returns over the last year of 33.5 per cent. It is also well ahead of the IMA UK Equity Income sector average, which has returned 21.57 per cent.
Performance of fund vs sectors over 1yr
Source: FE Analytics
Younes thinks the likelihood of companies putting their money to work in a meaningful way in the foreseeable future is unlikely – a view shared by manager of the CF Miton Special Situations fund James Sullivan.
"With growth expectations so low and debt so high, I can hardly blame management teams for not wanting to invest at this time," he said. "When you throw in the uncertainty surrounding monetary and fiscal policy, it’s hardly the ideal time to start taking risk."
Henderson UK Equity Income’s failure to hit its yield target of 110 per cent of the FTSE All Share index prompted its sector change. Woodford’s Invesco Perpetual Income and High Income funds – which are both currently yielding around 3.3 per cent – have also come under pressure for not hitting the target in recent months.
Yields have fallen across the board in the last couple of years, thanks largely to rallying share prices, which have diluted the rate of income companies are paying out. Younes says that the added risk of elevated valuations across the UK Equity Income market – and particularly large cap stocks that have proved so popular with managers – has put the asset class under even more pressure.
"In the first quarter of this year, you saw these yielding defensive companies go on a very good run, pushing valuations right to the edge," he said.
Performance of indices in 2013
Source: FE Analytics
"What can managers to now? Do they get out of these companies, which would mean sacrificing yield, and therefore change their mandate? This is the route James Henderson has taken, and it may or may not be behind Woodford’s decision to do something new."
Younes says his views are influenced by those of FE Alpha Manager Steve Russell, who told FE Trustnet in an interview earlier this year that there is a bubble brewing in dividend-paying large cap stocks.
Russell, who manages the Ruffer Investment Company, believes that negative real interest rates have – and will continue to – force investors into quality blue chip companies, pushing valuations onto dangerous levels.
Younes points out that some UK Equity Income managers who have traditionally gone down the defensive route have recently added to more growth-orientated stocks, perhaps reflecting this concern.
"Adrian Frost at Artemis has said repeatedly that there is good potential coming from the likes of Vodafone and Glaxo, but I find it interesting that he has recently added to his position in Rio Tinto, which is different from the kind of company he usually goes for," he said.
"I think there is a rotation going on in the equity market, and it’s up to the manager on whether they’re willing to be more flexible. That, I think, is why you’re seeing some managers do something a little bit different and go for a Rio Tinto."
"I think a lot of these stocks are at full capacity, and there needs to be a change in style. Maybe Neil Woodford sees this and believes the time has come to make the move. Remember his funds are a lot larger than everyone else’s, and so changing his style is much more difficult, because he has limited flexibility."
Younes believes that the limited upside potential in core equity income holdings could present an opportunity for multi-cap income funds that look beyond the FTSE 100.
"There are two ways you can go: you can either look to more growth-focused large caps, or you could look further down the market cap scale to find more growth opportunities there," he said.
"The issue here of course is that these kinds of funds can only grow to a certain size, otherwise they can’t invest in small and mid caps."
"Another thing to bear in mind is that the mid cap market has itself had a very good run. [Co-manager of the Jupiter Merlin range] Algy Smith-Maxwell says that one of the most dangerous places to be invested at the moment is UK mid caps because of valuations, so it is not as easy as just looking outside the FTSE 100," Younes added.
FE Trustnet profiled a number of multi-cap UK equity income funds in a recent study.
Mott, who manages Psigma Income, thinks Woodford’s new fund management venture could focus on start-ups, for which the manager has been very much involved in recent years. The tail end of Woodford’s Invesco Perpetual Income and High Income funds feature a number of micro-cap stocks, particularly in the biotech sector.
He is a major shareholder of e-Therapeutics and Retroscreen Virology Group, as well as a handful of unlisted venture-capital companies such as Oxford Nanopore Technologies.
