Webcast transcript from 7 October 2008 of Will Deer with Bob Yerbury & Neil Woodford from Invesco Perpetual & Invesco UK.

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Bob Yerbury:
While we all recognise that a degree of volatility should be viewed as part and parcel of stockmarket investment, the extreme conditions we have witnessed in recent months have been particularly challenging even for the most experienced investor. Throughout a long investment career spanning what is approaching 40 years, I have witnessed many economic crises and stockmarket storms.

If the experience has taught me anything it is that the key to successful long term investing is remaining true to your investment principles and philosophy. For us this means not being distracted by short term market momentum but keeping things in perspective and remaining focused on the fundamentals, identifying the best long term investment opportunities with the aim of delivering superior long term returns for our clients.

Allied to this dedication to investment quality, we are committed to supporting our clients. One way in which we aim to demonstrate this commitment is through the provision of information on a broad range of investment topics. We realise that in the current environment it is especially pertinent for us to share with you the views and opinions of our fund managers with direct responsibility for your client’s investments. Today I am delighted to be joined by our Head of Investment, Neil Woodford and UK Equities Product Director, Will Deer.  

Neil, who has been managing portfolios for us for over 20 years, exemplifies our conviction based approach to long term investment. In today’s interview he will be sharing with us his views on current market conditions, how his UK equity portfolios are positioned and where he sees opportunities in UK equity markets going forward.  


Will Deer (WD)
Neil can you comment on the current market conditions, how we got where we are and when you think we will be likely to pass through it?  

Neil Woodford (NW)
My view is that we got here through essentially excessive leverage and the cost of debt was far too low. Banks forgot about risk and priced risk inappropriately and I think at the same time regulation failed to intervene when it was required. So a combination of lax regulation and inappropriate cost of capital and poor risk taking has resulted in inflated balance sheets in the banking system, excessive leverage in the economy and excessive asset prices. This has all come home to roost I think at the moment.  

This crisis really started in the summer of 2007, and is rumbling on now. It has reached a pretty mammoth proportion and it is fair to say that it is a very serious crisis. I think the central banks know how to get out of this problem. They know what they need to do, it is just a matter of getting to the point where political will is sufficient for them to do it, because the decisions that they have got to take are unpalatable. Unpalatable because they are electorally unpopular, I would imagine. But I think the solution – to the immediate crisis – is in hand, I think, in that central banks and politicians now get it and I think we will see coordinated action internationally, but also domestically. And I think we’re going to see the UK, not just attempt to create liquidity or re-liquefy the banking system but also to recapitalise it effectively through some sort of nationalisation. So I think we will see that later this week. That won’t solve the problem but it will put an end to the sort of serious consequences of this crisis rolling on in an uncontrolled way.

WD
It sounds pretty gloomy from an economic perspective.  

NW
It is not good news. I have been cautious on the outlook for the UK economy for some time. I felt that we would see a slowdown in the UK as a result of the normal unwinding of the business cycle. But the credit crisis, the credit crunch and the crisis in the global banking system is going to make what was going to happen anyway a lot worse. So the outlook for the economy is very poor frankly over the next at least 18 months I would say, maybe even two years. We are likely to see a recession, falls in GDP, we are going to see higher unemployment, falling asset prices, falling commercial property prices and falling house prices. Generally it is going to be a very tough time. Businesses will find it very difficult, particularly those that are consumer facing and which are cyclical in nature.  

WD
Have you ever experienced conditions like this before?

NW
Yes, I was managing money in the early nineties, when we last saw a consumer recession in the UK, but all business cycles are different and I think this one will have its own particular characteristics. I, until recently, felt that the early nineties recession was probably more troublesome, more deep and more prolonged than anything we would see in the UK this time around. I now think that this recession could well be worse than what we went through in the early nineties. So things have changed quite a bit recently as a result of the crisis.  

WD
Do you feel your approach is well suited to the current environment?  

NW
I hope so. Yes, I think having been very cautious about the outlook for the UK economy and cautious about banks in particular, I have positioned the funds very defensively. So we have had overweight positions in businesses that I didn’t believe would be harmed by a setback in the UK economy and that has proved to be the right strategy for this environment. If anything I wasn’t cautious enough, but nevertheless it is the right strategy I think and the funds are positioned well for this environment. But I don’t want to get too gloomy either, because there are a number of businesses in the UK market trading on very low valuations, that will get through this tough period in very good shape, where I think we can make decent returns.  

WD
Have you changed your portfolio at all during these volatile times?

NW
Not really, no. There have been a few changes at the margin, but broadly the strategy has remained the same and as a consequence of that the holdings are broadly the same. Some of the weightings have shifted a little, but basically the portfolio is the same.  

WD
What is the outlook for equities?

NW
Well there are a number of different answers to that question, but I think for the overall market we are near the low point right now. It is hard to see the market going lower, particularly because I think we are within reach of a solution to the immediate crisis but that doesn’t mean that all equities are a buy. There are, as I have said, a number of businesses that will find life very difficult over the next two years and I think it is still too early to get bullish about some of those cyclical sectors. But on the other hand there are many businesses in the UK that are going to get through this period in very good shape that will be able to grow profits, cash flows and dividends over the next two years and I think those shares are looking very attractive at this point in time. So I think there is upside in this.  

WD
Where are the current opportunities?

NW
Well as I have said earlier the outlook for the economy is very difficult for the next two years. And consequentially the cyclical and consumer facing sectors of the market are ones that I would feel are going to struggle for the next, at least, 18 months. However, there are a number of sectors and a number of stocks in the UK market that aren’t exposed to domestic cyclicality and it is those that I think are looking very well positioned to get through the next two years in good shape. And they would include for example the tobacco sector, pharmaceuticals, telecoms to some extent and the oil sector, despite the fall in the oil price. I am still very optimistic about the cash resilience of those businesses, the asset resilience of those businesses and their dividend paying potentials. So those are four sectors that we are very keen on and where we have substantial weightings currently and expect them to do well over the next three to five years.  

WD
And what will you need to see before you change the shape of the portfolio?

NW
I think I would need to become a lot more confident about how deep and how wide, if you like, this recessionary valley is. I think at the moment it is unclear and therefore I feel it is too early to adopt a more bullish strategy. But I would say that over the next two years, as it becomes clear how hard this economy is going to be hit, then I think some opportunities are going to arise in some sectors that I have not owned for a very long time. And so we will be very vigilant about when the right time to buy those shares is.  

WD
Are you still confident about your ability to deliver absolute returns?

NW
Yes I am. I always look over a three to five year time horizon and make judgements about returns over that period. And from here I am very confident that the portfolio will deliver very good returns over that period and ahead of other risk assets. So – albeit that the period is going to be tough for the market and for the economy, I am confident that we will deliver good, positive returns over that period.

WD
What are your recent observations concerning investor behaviour?

NW
In the last few years, generally holding periods have declined substantially. Such that the average holding period now in the UK equity market is probably below six months. So I would say that reflects a much more short term focus in the market generally. As I have said we have a much longer term approach. Our holding period is over five years and we seem to be doing something quite different from the market and I think that helps to explain why we’ve been able to perform well.  

WD
So have equities had their place in the sun?  

NW
Not at all, no, I think the asset class – albeit selectively – looks very attractive on a three to five year time horizon. The overall index has been very disappointing now for a very long time. I think we’re now a lot lower than we were ten years ago for example in terms of index performance. But I think the asset class now is looking very bombed out and should deliver decent returns over a three to five year period and especially against other asset classes. 

WD
What advice would you give investors who are attempting to time the market?

NW
Well I am always very reluctant to give short term views on the market. I don’t call the market in the short term. But what I would say is that this is a very bad time to disinvest and on a three to five year time horizon, I think this is a good time to put money to work in the UK equity market, but I think you have got to be very selective as I said earlier. With the right portfolio, there is every chance of making very good money over a three to five year time horizon and I think the market is at a very low point.

Bob Yerbury
We recognise as always that our success depends on your success and we have a real commitment to support our clients through all market and economic conditions. In order to ensure we provide you with exactly the information you need, we are planning a series of webcasts and other supporting materials.  

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Webcast transcript