Neil Woodford of Invesco Perpetual talks to Rob Langston at the Fund Strategy Investment Summit.
Q: What is your view on the main macroeconomic environment?
A: The bank crisis resolution, the process of rebuilding [is ongoing]. In America, they are probably more than halfway through in terms of where they have got to go in terms of rebuilding balance sheets. America is further through the bank crisis resolution than Britain, but Britain and America are both further through than Europe.
Europe is just recognising that it has a crisis and is just beginning to recognise that lots of balance sheets need further to go [in terms of strengthening]. Banks are not behaving in a normal way and the economy is not working in the normal way because banks are shrinking their balance sheets. The normal flow of the economy is not functioning properly and the economy has not responded to the fiscal stimulus. It is not working.
The fact is that the banking system is broken, and as long as it is broken monetary stimulus will not work.
As the banking system remains un-repaired economic growth will remain subdued and will be vulnerable to shocks because we are not growing.
Q: How do you view the British economy in 2012?
A: As far as Britain is concerned the Chancellor is pressing with ’Plan A’. ’Plan A’ has helped reduce the deficit, but it may surprise you to know that despite the fiscal austerity government spending has still grown.
We have some economic challenges to grapple with. We are in the middle of a bank crisis resolution [where] credit growth is barely positive. In the near term we are looking at very subdued growth. It would not surprise me if we have back-to-back quarters of negative growth.
Oil prices have gone up quite a lot recently. When oil prices go up petrol prices rise and that squeezes the consumer. There is also rising tension in Iran, which could signal that oil prices may be going higher. (Q&A continues below)
Q: Are there any opportunities in the current market?
A: There is a relatively small group of companies that have been able to do well and will continue to grow returns. Two companies which have done this are BAE Systems and Capita.
Capita is benefiting from the fiscal austerity [in Britain]. Its prospects are improving as there is more pressure on budgets and [public bodies] are more inclined to outsource. In the past few weeks Capita has signed contracts to run the army’s recruitment and it has won a contract to do all the training for the civil service.
Elsewhere there is a whole series of special situations. Smith & Nephew is a medical equipment business and it has been a challenging time for this industry. A lot of elective surgery has been deferred by both central government-funded players and by individuals who have put off expensive operations because of budgets.
Other special situations include Reckitt Benckiser (consumer goods company), Provident Financial and Morrisons.
Q: Would you say you are defensively positioned in your equity portfolios?
A: I do not really like the definition ’defensive’, as I think it conjures up an image of hiding. Of course, I am protecting the interests of my unitholders, but I am not hiding in anything. What I am doing is making investment decisions that have the potential to deliver great returns to investors.
Q: What are your thoughts on the utilities sector?
A: Over the past 18 months, I have reduced exposure by selling out of most of the regulated utilities. That is because I believe the regulated utilities are failing to strike an appropriate balance between risk and shareholder return.
There is a huge amount of investment required in Britain’s electricity and gas infrastructure. It is my view that, particularly with electricity, the returns on incremental investment will not be attractive enough.
I have seen much better returns on other industries not supervised by regulators. [BT is a] utility where the government and the regulator recognise that they have to incentivise a lot of the infrastructure investment in broadband.
Q: Are you concerned by recent regulatory developments and corporate news in the pharmaceutical sector?
A: It is well known that there are challenges in the pharmaceutical sector, and they have been known about and focused on for a long time.
Western populations are ageing, which is supported by the rising dependency ratio, and one of the biggest challenges in terms of the developed economies for healthcare is ageing.
One particular problem is the central nervous system. There is no cure for dementia or Parkinsons and the cost of people suffering from it is massive. The American economy has a GDP of $15 trillion and the view of experts is that between now and 2050 the American economy will have to pay $15 trillion to treat the problem.
Q: Are there any positives in the banking sector at the moment?
A: I am not a big fan of banks – some are completely uninvestable. Certainly, some banks have only just scratched the surface of the problems [facing the sector].
HSBC and Standard Chartered are two of the best banks. I cannot think of any better banks globally. But being the best bank in a challenged sector does not make it a good investment. As you know, I do not start with the index [when constructing a portfolio], I start with ’how do I make any money?’ I do not have to have any allocation to sectors at all. And, in terms of other financials, I do not have any exposure to the life insurance sector either.
Q: What is your outlook for British dividend growth in 2012?
A: For the market as a whole, it depends on some of the larger stocks. BP has just announced a reasonable dividend. There is an expectation that the banks will start paying dividends. I do not think that is the case at all. I think it is hard to get too enthusiastic about dividend growth.