Is Neil Woodford's High Income fund too big?

As a result, the fund continues to be very popular, attracting significant inflows and featuring on broker buy lists. However, Invesco Perpetual High Income has received a birthday present it might not have wished to get. Wealth manager Sanlam Private Investments has dropped both Invesco Perpetual High Income and its sister fund, Invesco Perpetual Income (GB0033053827) - also run by Mr Woodford - from its influential White List of recommended funds.

Sanlam draws up its lists of UK Equity Income sector funds with seven criteria based on performance, volatility and income distributed. It focuses on the past five years with the most recent period of performance receiving a greater weighting.

The White List highlights managers who have been able to generate risk-adjusted returns over the previous five years while producing an attractive level of income for investors. Mr Woodford's funds are now on the next rung down, the Grey List. "The Grey List can act as an early-warning signal for a struggling fund, but can also chart the rise of a new star or provide a temporary home for a high-quality manager with an out of favour style," explains Sanlam.

But Sanlam has concerns beyond recent numbers. "These funds have, unsurprisingly, attracted a huge amount of assets, with Mr Woodford now responsible for more than £20bn at Invesco," it warns. "The funds have a long-established negative view on the economy and have selected defensive holdings that can ride out a period of low growth. This, and the aforementioned assets under management, has led the portfolios to become very focused in many of the very large stocks in the market. We would prefer managers who are able to be more pragmatic in the face of swiftly changing circumstances and therefore place sell recommendations here."

Invesco Perpetual High Income is £11.9m in size and Invesco Perpetual Income is £9bn.

Source: Morningstar & *Invesco Perpetual

Sanlam feels that liquidity in holdings is a very important attribute in the current environment and that these funds may struggle to change significantly if necessary.

But there is nothing new about Mr Woodford and his funds attracting criticism.

"Invesco Perpetual High Income has had accusations of being too large for well over a decade, but in the last few years the fund has grown at around the same rate as the fund has performed," says Adrian Lowcock, senior investment manager at Hargreaves Lansdown. "So in 2011 Invesco Perpetual High Income returned 9 per cent while assets under management grew 9.68 per cent, likewise in 2012 the fund returned 7.7 per cent while the assets grew 9.36 per cent. Mr Woodford is still able to manage the fund and take some quite strong conviction views on the market."

The fund's top 10 holdings account for more than half (57.64 per cent) of the fund, which results in high stock specific risk, though notably Mr Woodford had sold out of banks before their problems emerged. The top 10 holdings are also very liquid, while Mr Woodford has a low turnover. Investments in the Invesco Perpetual High Income fund are held for an average of 15 years, and he generally only trades 20 to 25 per cent of his portfolio each year.

Invesco Perpetual High Income top 10 holdings as at 31 December 2012

Source: Invesco Perpetual

Long-term performance

If you look at Invesco Perpetual High Income's position in the Equity Income fund sector on an annual basis, it tends to veer from being at or near the top to being near the bottom. This is not because the fund is volatile - it tends to produce positive returns in most years - but rather because Mr Woodford sticks to his investment style. He takes a very defensive stance so he tends to get left behind in market rallies but in difficult years he protects the downside far better than most other managers.

Invesco Perpetual High Income annual returns (%)

Source: Trustnet as at 5 February 2013

For example, during the financial crisis in 2008 Invesco Perpetual High Income lost less than the FTSE All-Share and most UK equity income managers but in 2009, despite a return of around 10 per cent, it lagged behind most funds in the sector because Mr Woodford didn't hold the volatile cyclical shares which rose at the time. Cyclical shares' value tends to follow changes in the business or economic cycle. Property developers and automakers are traditional examples.

"As a contrarian investor, Neil does have periods of underperformance but has been right on the two big sector calls over the last 15 years," says Darius McDermott, managing director at broker Chelsea Financial Services. "These are not holding technology media and telecoms in 1999 to 2000 and no banks in 2008. He has also correctly called secular growth in tobaccos from the early 2000s and it was a great investment."

During the technology boom in the late 1990s and the turn of the millennium, Mr Woodford avoided speculative technology companies and for a while the fund lagged behind the stock market as money flowed into these sectors. However, the strategy paid off as he shielded investors from the worst of the subsequent crash, and though the fund underperformed the FTSE All-Share for a while it came back strongly afterwards.

"Neil Woodford takes a strong disciplined approach to investing with a focus on what will drive the company's dividend price and growth in five years' time, not just now," adds Mr Lowcock.

Invesco Perpetual High Income long-term performance

Source: Morningstar as at 1 February 2013

Mr Woodford's current big sector call is pharmaceuticals. This is an area of the market that has been out of favour in recent weeks and months as the recent rally has been centred around banks and commodities. The fund also hasn't performed quite as well as some of its peers in the last year due to his defensive stance.

Invesco Perpetual High Income sector breakdown

Source: Invesco Perpetual