Mitchell Fraser-Jones: So, Neil, we're going to start with a question about recent performance. I think it's fair to say that the funds had a challenging summer. Can you tell us why you think the fund is underperformed over the last few weeks?
Neil Woodford: You know, we've had a really difficult two months really. July and August have been particularly difficult. I think there's a temptation to focus on the company's specific issues and think about events that have taken place within individual companies that have resulted in share price fall. So for example, AstraZeneca announced the trial results, actually along with very good results and a number of other very good very positive things.
But nevertheless, the market focused on a negative outcome for the progression-free survival endpoint for the Mystic trial, which is an important trial for Astra. And nevertheless, that was a sort of an event that the market focused on. The share price fell 15%. It's the biggest position in the portfolios. And of course, that was quite damaging to the funds in terms of the hits.
Then, of course, there was Provident Financial that came in June originally and then, again, a few weeks ago with another profit warning. That company saw a gigantic fall at one stage. It fell nearly 2/3rds on one day. And that followed two profit warnings, which we've talked about on the blog.
And I think it's tempting to think, well, maybe the underperformance is a product of these sort of company specific problems. And certainly, they've not helped. But for me, when I think about the portfolio in the round and think about what's happening in the stock market, more broadly, and what's happening in the portfolio, the underperformance is a product much more of the rather odd characteristics of this bull run in the stock market. It is a very narrowly-led market. The stock market seems to want to bid up the prices of stocks that I've talked about before, which provide exposure essentially to Chinese credit growth.
MFJ: What do you mean by Chinese credit growth?
NW: Well, Chinese credit growth has been very strong. As you know, the administration in China has highlighted the importance of-- the paramount importance, frankly, to the administration in China is achieving a 6.5% GDP growth number. That has become the singular focus really of the administration, particularly, ahead of a very important 19th party Congress in November, early in November, where Xi Jinping will be sort of reasserting his authority over the party and over the economy, not just in terms of the current administration, but indeed looking forward for the next five years. So it's very important for the administration to have a very sort of strong and benign lead up from an economic point of view to this Congress in November.
And of course parts of the market that don’t deliver other bits of the market we’re I’m seeing a lot of value. So domestic economic cyclicals health care and indeed our small early stage portfolio none of those parts of the market provide any exposure to this sort of this one dimensional story that the market really loves.
MFJ: How is that having an impact on the UK stock market?
NW: In very simple terms, the stock market has decided that Asia, China is good, the UK is bad. It's a very sort of-- it sounds very simple. And maybe it is an oversimplification. But I see-- I see that driving-- I see that preference playing out in the stock market daily.
And we can use all sorts of stock examples to highlight why or how the stock-- the consensus really-- I'm talking about consensus here. When I talk about the market, I'm talking about a consensus view. The consensus view is playing out by bidding up stocks that give exposure to this sort of Asian and China credit growth story and exiting out of anything really that doesn't deliver that. And of course, parts of the market that don't deliver are the bits of the market where I'm seeing a lot of value-- so domestic economic cyclicals, health care, and indeed, small early stage portfolio.
None of those parts of the market provide any exposure to this sort of-- this one-dimensional story that the market really loves. I worry that the story that the market is chasing at the moment is dangerous. And that's why I haven't wanted to play that story.
MFJ: How does it how does it make you feel when your funds go through a period of performance like this?
NW: So it's incredibly painful and difficult thing to have to navigate. I'm very disappointed with the short-term performance and indeed, have been criticised for it. People on our blog have been criticising me. I've been criticised in the media.
And I think I'm right to be criticised. It's been a difficult period. And I'm very sorry for the poor performance that we've delivered really now since 2016.
But in terms of what it means for me as a fund manager, it's very, very important that through a period like this that you maintain your investment discipline. I think we've rehearsed with investors many times how I invest, what I look for, why I'm thinking what I think, what's driving my investment decisions, and to remind people, in short, it's the fundamentals of the economy and the businesses I'm investing and indeed, sometimes the businesses I'm not investing in. But I'm trying to focus my investment attention always on what's really happening in the real world. That's what I mean by fundamentals-- I mean, the real activity in the economy and the real activity-- the real performance of the businesses that we're investing in, not with the stock market perception or the stock market prejudice, but the reality of the real world.
That's what I focus on. And then I apply a valuation overlay to all of that. What's the right valuation for the businesses that I'm investing in and indeed, the ones I'm not investing in?
Where is the market making an error? Where has the market got the wrong end of the stick? Has it distorted reality? And it often does.
It did it before. It's done it on numerous occasions in my career. And it is certainly doing it now in my view. That is a painful place to be.
And all the temptation is to move away from that and to soften that and to go and do what everybody else is doing but more minors, sell the UK cyclicals, and just hide in the group where everybody else is investing. Maynard Keynes said one day that well, he's I mean, not just a brilliant economist, but he was a very successful fund manager. He said, it is often better to fail conventionally than to succeed unconventionally. And I think it's at times like this I remember those words, because it is-- the pressure is relentless to do what everybody else is doing.
And that's a bit like when I was playing rugby at a reasonably good level a few years-- quite a few years ago now, pre-season training was always really tough. You would push yourself really hard after-- maybe after two months off the summer. You know, you'd feel really ill at the end of the session if you pushed yourself really hard. You'd lie at side of the pitch wanting to be ill. And eventually, half an hour later you got over it.
But you put the hard yards in, because you knew it was the right thing to do. It would have been easy to back off a bit. But of course, that would mean that when the season comes, the tough season, the tough games you're going to have in ahead, you wouldn't be fit enough. You wouldn't be as prepared as you should have been.
The temptation is to take the easy option, to sort of hide-- as I've said, to hide in the strategy that everybody else is pursuing. And then all the attention, and all the fuss, and all the criticism would go away. But as I've said, that would be a betrayal of my investment principles. I believe entirely the wrong thing to do in terms of the long-term interest-- medium and long-term interests of our investors.
MFJ: Can we turn to Provident Financial now? Will you talk a little bit about what's happened to that business over the course of the last few months?
NW: Clearly, owning as much as I did in Provident Financial has been harmful for the funds, because the stock has fallen a hell of a long way, in my view a disproportionate amount. Clearly, the share price should have fallen to reflect the profit warnings that we've seen. But I think the stock market, yet again, has become hysterical and, yet again, has multiplied many times the impact of all of this problem in the home credit business.
So what they announced in June was that the business disruption that had resulted or that had followed the decision to change the business model from an agency and commission led model to an employed sales force model, which in the process of executing that reorganisation, resulted in about 2,000 redundancies. The business disruption associated with that shift had been more severe than the company had anticipated and that the profits would fall by $50 million in that division from about $110 to $60. That was what we found out in June.
So we engaged with the company. I had a number of calls with management. We had a very long and fruitful meeting-- we thought fruitful meeting-- with the management in Oxford.
And at no stage from any of that engagement or involvement with the company did we get any sense that the problems were worse than we already knew. What happened subsequently is that the business disruption was even more significant than we had thought, so much so that the profits were going to fall substantially further. And instead, of making $60 million, the board have now guided to losses in that division of between $80 and $120 million.
MFJ: So I guess I'll follow-up on that. But I was just asking you whether you ever questioned or how you questioned the relationship of trust that you have with management teams. How do you know whether to believe what a management team are telling you or not?
NW: So again, with the benefit of hindsight, lots of people are saying, well, either the management lied to you, or you are naive, or you weren't listening. What the hell was going on? Well, I think there's a bigger point here.
The bigger point is, as a public market investor, you have to accept that there will always be some fog between you and what's going on in a publicly quoted business. The regulations that surround what I do ensure that there is a distance. There isn't a complete and an open flow of information from a public listed equity to an investor.
It is always the case that you can't and don't know all the things that you want to know about what's going on in a publicly quoted business. And that's the frustration. It actually may be a surprise to our investors. But it is the fact of life that the regulatory environment that sits around public markets ensures that I can't know all the things that I would want to know, certainly, for example, in a case like Provident Financial at a really important time like this.
MFJ: Is very different than to an unquoted company?
NW: Yeah, it is. It's really good to compare and contrast. In unquoted businesses, we have a much closer relationship. There is no regulation of the flow of information from unquoted business to a shareholder.
So we attend board meetings. We see management accounts. I mean, we know everything that's going on in the unquoted businesses that we invest in.
It doesn't mean we won't make mistakes, but it absolutely doesn't mean that we have a much more intimate knowledge of everything that's going on in that business. In a public market business, you cannot know all those things that you want to know. And that naturally puts constraints around the amount of information that you have and the quality of that information. So you have to make judgments all the time.
The important point here is that you have to trust what people are telling you. Clearly, you go away and exercise your judgement and analyse what they've told you. And if it doesn't make sense and it doesn't correlate with what you've learned elsewhere, then, of course, you ask questions. And of course, you make judgments back in the office about what you've been told, but the starting point must be that you trust management to tell you the truth. And if you didn't, you shouldn't be investing in public equities in my view.
MFJ: OK, move on to a couple of other kind of questions that we've come in, some of which kind of are linked to what's happened to the Provident Financial, but some of them are slightly more broader general questions. I think as far as Provident Financial is concerned, it was a big position in the funds. And we owned a large stake in the company. We have had some people suggesting that we shouldn't be owning such large stakes in business. Can you explain why you're comfortable taking such large stakes?
NW: For 30 years now, I have been running money in a very active way. I have never been a closet index manager. I've always taken strong views about where value is in the stock market. And I have for all of that period been taking big stakes in small companies and big stakes in big companies. And I'm very happy to do that.
I don't believe that there is a problem with owning a large stake in a business that is profoundly undervalued. My career has been built on taking big bets in businesses that have been profoundly undervalued. I think it is entirely appropriate and entirely consistent with what we say we do with respect to our managers.
Clearly, lots of active managers who have closet index portfolios will be quite happy to have very small stakes in businesses. But that isn't how I run money. That has never been how I have run money. And it will always be a characteristic of what I do going forward.
And I'm very happy about it. I mean, we build these positions over a period of time as we build conviction, both in terms of the attractiveness of the business and what it can deliver, but equally as we become more convinced of the undervaluation opportunity in that business. So we want on behalf of our investors to capture the best opportunities on the greatest scale.
MFJ: When you look at the returns that you've achieved over time and the long-term approach, clearly, you're feeling confident on the normal three to five year view. Do you think that you're going to have to wait quite a long time for the fund to show a significant turnaround? And that's difficult to say.
NW: It is difficult to say, but I'm really confident about how the portfolio is positioned. It hasn't played out in terms of investment performance. But when I look at the portfolio and think about the businesses that we're investing in and think about how well they performed as businesses, I remain very confident about that underlying valuation opportunity playing out in share prices in the relatively near-term.
My job is to focus on what's really happening in the real world, not to get distracted by themes that play out in the stock market. They can often be like mist on an October morning. You know, it'll just evaporate very quickly. What I’ve got to do is focus on things that are consistent with my investment approach, things that drive long-term fundamental value. That's what I focus hard on.
And when I keep asking those questions day in, day out, I keep getting the same answers, which is that the portfolio is structured in the appropriate way. We're exposed to the right sorts of businesses that are performing well, who share prices are not reflecting the underlying good performance, but they will. And I'm pretty confident they will in the relatively near-term too.
There's huge potential in the portfolio, huge undervaluation. And it's a great portfolio, one that I own and want to own more of. The short-term performance is painful and is difficult, but it isn't a permanent loss of capital. And I can and I believe I will rebuild the performance and rebuild that capital that we've lost recently.