Fund research group Morningstar has downgraded its rating on the Woodford Equity Income fund, arguing fund manager Neil Woodford's 'relentless willingness to push the portfolio to its liquidity limit' had resulted in 'extreme positoning' of the £4.3 billion fund.
Associate director Peter Brunt downgraded his rating on the fund from 'bronze' to 'neutral', saying Woodford's 'increasingly extreme positioning and related risks of this strategy have led to a further reduction in our overall conviction'.
Brunt highlighted the 'extreme action' taken by the fund manager to keep the fund's exposure to unquoted companies below the 10% portfolio limit imposed by the City regulator.
'A combination of poor performance of the quoted portion of the portfolio, persistent redemptions, and the delaying of several unquoted names from initial public offering forced the group to take extreme action to keep unquoted exposure below the 10% limit,' he said.
'While so far it has successfully managed to meet the demands, the portfolio now has one of the least liquid profiles in the market.'
Citywire revealed in March that Woodford had listed some of his stakes in unquoted companies on Guernsey's International Stock Exchange in order to stay within the limit. Without those listings, his exposure to unquoted companies would stand at 18.4% of the fund.
The manager has also swapped £73 million of the Equity Income fund's stakes in unquoted companies for shares in the Woodford Patient Capital (WPCT) investment trust he also runs. Shareholders in the trust effectively gave the green light to further swaps by passing all resolutions at the trust's annual general meeting last week.
Woodford's flagship fund is rooted to the bottom of the Investment Association's UK All Companies sector over three years, down 12.8%. The fund has more than halved in size since peaking at £10.2 billion in March 2017.
A Woodford spokesman said Link, authorised corporate director of the fund, provided 'independent liquidity oversight' as well as being responsible for the fund complying with investment restrictions and liquidity and valuation requirements.
'Liquidity limits and stress testing are all agreed with Link and monitored by both Link and Woodford and via discussions with depository Northern Trust ,' he said.
'The fund is managed so it can stay within its agreed liquidity limits and these are set conservatively so the fund can comfortably meet any redemption as they fall due.'
While Woodford's exposure to unquoted companies has grown to occupy a significant portion of the portfolio, the shape of the rest of the portfolio that is invested in quoted companies had undergone a 'striking evolution', said Brunt.
But after overhauling the fund in the summer of 2017 to target stocks focused on the UK domestic economy that he believed had been punished too hard by investors' reaction to the Brexit vote, the shape of the fund began to change dramatically.
'With these typically being smaller in size, the market cap profile of the portfolio saw a striking evolution,' said Brunt.
'Within the listed portion of the portfolio, small caps and mid caps accounted for 40% in January 2016; by the end of March 2019, they stood at 95%.'
Brunt argued Woodford's shift in approach also meant the manager's strong track record during more than a quarter of a century at the helm of the Invesco funds had less of a bearing on the manager's current plight.
'While we give credence to this long-term record, the now highly differentiated portfolio reduces its relevance,' he said.
Morningstar's downgrade of Woodford's fund follows a cut in its rating from 'silver' to 'bronze' this time last year.
Online stockbrokers AJ Bell and Charles Stanley Direct removed Woodford Equity Income from their fund buy lists last year. But Hargreaves Lansdown, the biggest backer of the fund with a stake worth £1.4 billion at the end of last year, has retained the fund in its Wealth 50 selection.