Woodford or Barnett, who is the better manager?

WOODFORD OR BARNETT, NEIL OR MARK? IS THIS REALLY THE RIGHT QUESTION FOR INVESTORS?

Since Neil Woodford’s resignation from Invesco Perpetual was made public in September 2013, there has been debate and discussion about who, Woodford or his ‘successor’ Mark Barnett is the better manager.

Barnett has long been groomed for the role in which he now officially finds himself – badged by the market as the ‘new Neil Woodford’ – and has been given stewardship of a number of the funds which Woodford ran for two decades.

Any conclusion becomes more difficult to reach when looking at historic performance achieved when they worked together under the roof of Invesco Perpetual.

Over a decade to 31st March 2014 Woodford’s performance is on par with Barnett, but that partially hides that over this period he was the more established, experienced manager who already had an impressive pervious 10-year record under his belt.

Barnett, however, only took the helm of the UK Strategic Income fund in 2006, which was the first time he had consistently been at the helm of the Invesco Perpetual fund and started developing his style.

But does his style owe its roots in the bottom-up stock picking which characterised Perpetual from the 1980s or 1990s, or the more centralised style of Invesco post its acquisition of Perpetual.

Woodford’s deserved reputation is built on his long-term Warren Buffett-like style of buying stocks when they are cheap and out of favour and waiting for the market to see that value.

It has been described as a ‘contrarian’ and lead to periods where he under-performed relative to the broader market, normally during periods of ‘irrational exuberance’, most notably the dotcom period at the beginning of the century.

Barnett’s style is more pragmatic with a portfolio more broadly spread up and down the market cap scale. His historic exposure to smaller and mid-cap stocks could be part of the reason the two managers’ performance began to diverge towards the end of 2012, with Barnett ‘outperforming’ from this period.

Woodford by contrast has historically been large cap focused, including making good use of his ability to hold up to 10% of his portfolio in international stocks, which has seen him hold everything from Hong Kong-listed businesses through to US tobacco companies.

Because of the large inflows his funds have experienced in the last decade Woodford has also been able to hold a meaningful portion of his funds in unquoted companies, which may have been another reason why his shorter term performance lagged Barnett’s.

Woodford has indicated he will carry this strategy into his new funds, and may even take over some of the unquoted stocks from the Invesco Perpetual funds into his new fund. What impact will this have on his future performance?

So is it a simple choice between the two managers, and if so who should you pick and why?  More importantly how will the two managers perform looking forward?  We have reviewed the two managers, using our advanced PureResearch Forward Perspective Model, to identify potential differences between the managers and whether or not these will persist into the future.

It is clear that both Woodford and Barnett are very good long-term managers, delivering in excess of 200% returns over 10 years[1].  They have shown historic close correlation, which may well be more due to the Invesco Perpetual house style, although interestingly performance has begun to diverge in the most recent periods.

Woodford Table 1

Undoubtedly there has been a consistency in style between the two managers, with both managers running similar exposure to factors such as market risk, sensitivity to UK inflation and UK term spread.

Both managers have historically had a low exposure to market risk, which is not surprising for income based funds, and have had a negative position on UK inflation. Whether or not this was imposed by a central Invesco Perpetual house style or shared investment decisions, it shows that both managers have shown similar characteristics.

However, under further inspection there have been changes in the two managers’ strategies in recent periods.  This is most clear when you look at their sensitivities to both default spreads (BBB minus AAA rated corporate bond yields) and UK dividend yields (the total annual dividend payments divided by market capitalisation), where 2 years ago there was a significant change in style between Woodford and Barnett.

It can be seen in the chart below that as default spreads tighten from December 2011, both managers reacted by reducing their positive exposure.  Importantly Barnett continues to reduce his sensitivity to default spreads and in Q4 2012 eventually takes an opposing position relative to Woodford’s UK Income fund (red line).  From this date forward Barnett’s UK Strategic Income fund (blue line) will have benefited more from his lower exposure to default spreads relative to Woodford.

Woodford Chart 1

With UK dividend yields we see a fundamental change in position between the two managers in the second half of 2012.  Here we see Barnett potentially taking a bearish position relative to Woodford with his positive exposure to dividend yields – dividend yields rise as stock prices fall.

Woodford Chart 2

With Neil Woodford and Mark Barnett working together at Invesco for such a long time, it is not surprising that their styles have historically appeared to be similar.  However, subtle these two positional changes are, do they offer a guide to how these two managers will develop their styles in the future?

Is not the real question now, not which manager to select as they are both quality managers with proven track records; but now with the two managers working at separate companies, but in the same fund sector, will they become two different investment ‘beasts’?

Will Woodford unconstrained by the Invesco Perpetual centralised house view deliver an enhanced version of his style that has typified his management to date without increasing the risk profile of the fund, and will Barnett, now out of the shadow of such an illustrious manager, be able to continue to develop his own style?

Investors who have invested with Woodford for a long time, will no doubt feel inclined to invest with his new fund. For these investors consideration should be given on whether to move existing money to his new fund, or leave it  as it is, now under the stewardship of Barnett, and  place new money with Woodford. The answer to that will be based on individual investor circumstances, including specific tax positions and long-term investment objectives.

For investors looking purely for a long-term income stream as part of a retirement income solution, the answer may be to have a spread of UK Equity Income funds which have more of a discipline of creating a distributable income stream from the portfolios. Woodford’s funds have been total return funds with an income option, whereas Barnett appears to have more of a bias to higher yielding equities.

What is certainly the case is that the separation of these star managers will only benefit the UK retail investor who is looking for options and competition in the UK Equity Income sector.

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[1] Mark Barnett started management of the UK Strategic Income fund January 2006

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