The collapse of Woodford Investment Management and the shuttering of his funds is still causing issues for other fund managers almost five years later, according to James Henderson.
The biggest consequence of the Woodford scandal, in which the disgraced fund manager invested heavily in unquoted or illiquid stocks – ultimately leading to the firm being unable to pay back investors who were trying to withdraw their money – is that investors now place a premium on liquidity.
This will cost them, however, when illiquid areas of the market such as smaller companies start to recover.
That’s what Henderson and co-manager Laura Foll are preparing for in their Henderson Opportunity Trust. It was hit harshly by investors’ attitudes turning sour towards the alternative investment market (AIM) three years ago, as the chart below shows.
Performance has dwindled somewhat in the past decade as well, with the vehicle slightly underperforming the rest of the IT UK All Companies sector over the past 10 and five years.
But Henderson is excited about the opportunities in AIM, as he explained below. He also discussed how much the economic backdrop impacts a company’s success and why there’s no such thing as a forever-stock.
Performance of fund against sector and index over 3yrs
Source: FE Analytics
What is the fund’s process?
We invest in a diverse list of stocks that often aren't in the mainstream. We're looking for the forgotten, unloved stocks and this always brings in a medium- and small-company bias to the fund.
We use different valuation methods for different areas of the market. We have a recovery theme going on at the moment and for a recovery stock, we're looking for turnover and not wanting to pay much for it.
Another area is tomorrow's winners. These are the often small companies that we believe will be more substantial in the future, so we're looking at prospective turnover and how they're compounding their earnings.
Why should investors pick your fund?
It's meant to be a real mixer in people's portfolios. We don’t see it as a one-stop shop, but as complementary to other things investors hold, as there won't be much crossover with more index-orientated funds.
Admittedly, it's a difficult fund to choose. The alternative investment market (AIM) hit a brick wall three years ago, which hasn’t helped. There aren't many funds looking in that area anymore and since Woodford’s funds imploded, there has been a real pressure on liquidity.
People may be paying too big a premium for liquidity. In the investment trust structure, we can take a slightly longer view and buy some illiquid stocks, because that's where the valuation discrepancy is greatest. That's where the excitement is and the recovery will come through.
How much is the performance of recovery stocks linked to the economic recovery of the UK?
Companies can achieve great things even with headwinds. Last year, Marks and Spencer recovered despite the cost-of-living crisis. The recession was very mild, but it still would have been a headwind and being one of the biggest names on the high street, it could go against the general economic climate.
If you provide excellent services or products, the overall economy doesn't really matter, and that'd be very much the case with some of tomorrow's winners as well, for example alternative energy stocks.
Whatever happens in the economy, if you're beginning to answer the energy problem so that people can move away from fossil fuels, it doesn't really matter what happens to the overall economy or interest rates: you're going to have a good business.
However, a bank is more closely tied to the economy, obviously.
Does this mean there are inherently good companies that you could potentially hold forever?
The lifecycle of companies is getting shorter and people don’t stay at the top of the tree forever. I would be careful about paying high P/Es [price-to-earnings ratio] for companies that are performing well. It's a very competitive world and there will always be people taking on the person at the top.
With the internet and things like price comparison websites, a company that starts to fail, doesn't have the best product, or is not giving the best service, is found out quicker than it used to. That's why we rotate out of the successes over time and into things that are more challenged, companies that are losing today that can recover.
How does this impact portfolios and turnover?
You need to be moving on a bit quicker than in the past. I can't envisage buying a share and thinking I'll never sell it. Turnover used to be about 15% and now it'd be closer to 25%. Average holding periods are also shorter, every five or six years we're turning things over. There are fewer forever stocks now.
Is Warren Buffett wrong then with his hold-forever philosophy?
In the English market, there aren't stocks like Coca-Cola. Every company that's been at the top in the UK has also declined over time. Vodafone was once a huge percentage of the UK index – while it’s still a very popular product, it's been dreadful for a long time.
However, even Coca-Cola wouldn’t be a forever stock. The world moves on even for it.
What were the best and worst calls of the past 12 months?
Our timing with Rolls Royce, which became the biggest holding in the fund, was lucky. It recovered much quicker than I thought it would. It was bought between £1.10 and £1.20 and the price now would be over £4.10. I've reduced it this week.
Our biggest drawdown last year was Zoo Digital, which does the dubbing for film productions. With the writer strike, it was hit big and then since it's opened up again, it hasn’t got back the amount of work it had before, as production companies do more in-house dubbing.
It has a good management team, but the area is much more difficult. The share price has been falling and we have cut it. The share price has fallen from £1.50 to £0.50.
What do you do when you’re not managing funds?
I’m very excited about getting into Bologna later in the month, as we've lent a picture to a show just outside Bologna on the pre-Raphaelites and Botticelli. They're showing how the Italian masters influenced English Victorian painters.