4 take-home messages from the Neil Woodford debacle

It’s probably fair to say that last week was one that Neil Woodford and those that backed him would prefer to forget.  

So what can we — all Foolish investors — take from this nasty episode?

1. Don’t believe the hype

Go back a few years and Woodford’s record as a stock-picker was virtually unmatched.

Notwithstanding this, recent events remind us that past performance (still) isn’t any guide to the future and that anyone — star fund managers included — can make mistakes that threaten their reputations. 

Of course, Woodford’s troubles give those who favour low-cost passive investments more ammunition to argue that the vast majority of fund managers, even those with impressive backgrounds like his, aren’t worth investing in. Even if they do outperform, the fees they charge eat up a huge chunk of these gains anyway. 

If last week hasn’t put you off being in active funds, make sure that you’re not relying on the skills of just one person in the same way you wouldn’t rely on the success of one particular stock. A degree of diversification is always required. 

2. Know what you own

The problem with Woodford’s fund is that it was invested in a lot of illiquid holdings.

That’s fine when the going is good but it becomes a major problem when hard times hit because it means that a manager is forced to dispose of liquid (i.e. easily traded) stocks in order to satisfy redemptions as everyone runs for the exits.

This increases the amount of illiquid holdings in the portfolio, which puts it at risk of eclipsing limits imposed by regulators. So Woodford now needs to jettison these stocks too. 

I’d bet many of those invested in his flagship fund were unaware of all this, highlighting the importance of regularly checking that the person entrusted with managing your money is continuing to follow the strategy originally outlined.

3. Know your horizon

In addition to knowing the above, it’s also essential to consider how long you plan on leaving your money there. 

I’ve read reports of stressed holders who fear being unable to make up any losses because they’re already in their twilight years.

Without wishing to sound harsh, that’s not Woodford’s fault. That’s just bad risk management, either on the part of the holders or, if applicable, those advising them.

Put simply, if you have all your money tied up in shares, you must understand that you may get less back than you put in. That not a great position to be in if you’re already retired.

I’m certainly not advocating that anyone about to leave work for good should come out of equities completely, but the past week illustrates why a gradual move to less volatile assets is prudent. 

4. Be a quality-focused contrarian

Being “greedy when others are fearful” is good advice for long-term investors. Neil Woodford famously made his biggest gains when he bought big stakes in tobacco companies when everyone else despised them. 

But this Buffett-sourced sound bite misses out the importance of only buying stocks of sufficient quality (high returns on capital, good operating margins, low/no debt). Many of Woodford’s big bets, such as Purplebricks, AA and Capita fail this last test. 

If you are going to zig while others zag, make sure you go in with your eyes wide open.