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19 May 2016

Extraordinary monetary policy is a necessary evil

There are lots of risks in the UK market at the moment, according to Neil Woodford, manager of the Elite Rated Woodford Equity Income fund. “There are a number of bear value traps—companies that look enticing but could be a bad investment—especially among the UK's largest companies, some of which are paying large, but unsustainable dividends.”

Neil likes to avoid this type of company, preferring those which are generating returns and are able to continue to do this in a low growth environment, not relying on capital or debt. He firmly believes you can't judge the future cash flows of a company without putting it in context of the market backdrop and the company's position within it. He wants to know how well a company will survive and prosper in the future world. These are the same fundamentals and principles he has used throughout his career and they are the anchors of his portfolio today.

“I've been cautious on the state of the world for some time now and, if anything, I'm even more cautious today.”

This caution is led by China, which looks fairly perilous to Neil. He believes it will suffer the consequences of a debt-fuelled infrastructure-led boom, which has left a toxic legacy of non-returning assets.

“It is a credit bubble that will burst and will look very similar to the credit crisis in Japan and the global financial crisis in 2008. However, the government set up will afford them more direct power to attempt to deal with it. Other issues aside, it is an effective model for sorting out a problem like this.

“That being said, they will start exporting deflation soon and that's not all. There are significant environmental problems, political unease and structural problems. The most appropriate solution comes from technological advances in energy, climate change and medical solutions, which can morph the economy to a more productive base with a higher standard of living.”

In developed markets, Neil is equally cautious. “Extraordinary monetary policy is a necessary evil in order to avert big crises, but many of the decisions made have been politically driven, not economically driven. Once you move to helicopter money, it opens the door to a whole load more issues. Essentially, it would be a watershed moment. It should only be the medicine given when the patient is otherwise at death's door.”

Given his views, Neil's portfolio currently looks very different from the UK stock market index. On a sector level, he holds no oil, banks or mining companies and has very minimal exposure to manufacturing and engineering. He likes healthcare, where he believes structural growth is not priced in, and also says tobacco is where pricing power has been missed by other market participants.

On a stock level, he likes Babcock, whose share price suffered from a mistimed acquisition, but the business has years of structural growth ahead of it in his view. He also likes Provident Financial, which is capitalising on the low credit finance market. Their customers have benefited from higher wages and cheaper food and fuel, which is increasing their spending ability and so propensity for credit cards.

Cumulative periods of bad weather has unduly affected Next, but Neil believes it is well defended against new online retailers, and while he doesn't usually like retail companies, this stock is a special case.


Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Neil's views are his own and do not constitute financial advice.