Reflections on the demise of Woodford and the nature of managing investment funds.Jan 9th, 2020
It has been argued there are three different kinds of problems in the world:
- Complicated, and
A simple problem is one where there is a (proven) ‘recipe’. Whilst there might be some basic techniques to learn, following the recipe brings a high chance of a successful outcome.Example: baking a cake.
A complicated problem may be broken down into a series of simple problems, but there is no straightforward proven recipe for the whole set. Success requires lots of people, or teams, and specialised expertise.Unanticipated difficulties are frequent, and time/cost estimates frequently wildly inaccurate.Example: a space mission.
Complex problems have outcomes that can be highly uncertain, but it is known to be possible to do it well, with past expertise. However, expertise is valuable but not sufficient. Example: medical treatment, large construction projects.
Historically, complex problems have been dominated by a lone ‘master’ (and it usually was a man) who wielded a lot of power over those who followed his lead and required an ego to match. But, the sheer variety and sophistication of technological advances has by and large overwhelmed the ability even of the most expert ‘master’.
The successful response has been to adapt to a managed collaborative effort between specialists. By and large, tall buildings don’t fall down despite ever increasing complexity, and aircraft don’t fall out of the sky. Of course, human failings can still short circuit even the best efforts, e.g. the Grenfell tower Tower fire in 2017, the collapse of the Morandi Bridge in Genoa in 2018 and Boeing’s 737 Max aircraft being grounded in 2019.
However, where the cult of the ‘master’ persists, bad outcomes still happen too frequently. For example, in medicine, where care is duplicated, flawed or uncoordinated, because nobody dares challenge the power (or ego) of a consultant.
Success for investors is fundamentally measured by reward for a given level of risk. On one view, investment selection is a simple problem: pick a handful of decent companies, watch them carefully and reap the reward of dividends over time. However, particularly for our clients who have critical needs that must be met now, investment selection is a complex problem. We know it can be done well, but outcomes are inherently uncertain.
Our task would be much easier if there was a fund manager who had the magic formula to weather all market conditions. We have yet to encounter one, so we stick with fund managers whose processes we approve and who we fundamentally like, trust and admire. We know and accept they will have their ups and downs. Of course, individuals come and go, organisations change and the world around them changes. Therefore, there is a need for regular re-evaluation and assessment of the alternatives, which is time- consuming and expensive.
Until earlier this year, Neil Woodford had a reputation for the Midas touch, managing to beat the market by ‘daring to be different’. When he left his long-time employer Invesco Perpetual to set up his own funds in 2014, the process was done in record time (3 months), and massively supported by those who had grown rich during the previous 20 years, including £3.6bn from St James’s Place Capital. Most of the money came from one source: Hargreaves Lansdown.
This is a sickening tale for anyone who put their faith in Woodford. His show is now over, having been ousted from the company and the funds being wound up. This is a scandal on a large scale and yet the regulator is keeping quiet.
Perhaps Woodford was once a ‘master’, but the world around him changed and had too much tied up in perpetuating a rotten arrangement. The simple message: beware the cult of individual ‘star worship’.