Woodford Patient Capital and the benefits of a closed-ended structure

As Simon Cowell might put it, investors didn’t like Neil Woodford’s new Patient Capital fund; they loved it. By the time that the investment company closed its fund-raising period earlier this week, it had raised £800m – and been forced to scale back some applications because the issue was over-subscribed.

We know why Woodford Patient Capital has been so popular. Neil Woodford is one of the UK’s very few star fund managers, with a sparkling long-term performance record that investors hope to see continue for many years to come. Even though this fund is a little different to his previous ventures – as well as Woodford’s favourite blue chips, it will invest in early-stage companies, included unquoted businesses – investors expect more magic.

Given his huge following, Woodford might have been tempted to structure his new vehicle as an open-ended fund, rather than an investment company.

In truth, however, the closed-ended structure suits this fund’s investment mandate much better. The big challenge now for Woodford will be to invest the cash he has raised – and to move from large cap stocks into the smaller plays that Patient Capital is all about. This is bound to take some time – evaluating early-stage businesses, especially those without a stock market listing, requires extensive due diligence. And even when the manager does decided to invest, its stake, in cash terms, is going to be relatively small. A closed-ended structure, with a fixed amount of cash to deal with, will give Woodford a bit of breathing space to get his portfolio right.

Further down the line, the closed-ended structure will really come into its own. The type of companies in which Woodford intends to invest, by their very nature, tend to perform in fits and starts. Even where these companies are listed, trading may be illiquid. The fund will need to have the freedom to take a long-term view, which is what the closed-ended structure gives. In an open-ended fund, the constant inflows and outflows of investors’ capital – which may be influenced by all sorts of factors beyond Woodford’s control – would be much more challenging.

It’s interesting to note the nature of some of the other blockbuster investment company launches of years gone by. Most recently, another British star fund manager, Anthony Bolton, raised £460m for Fidelity China Special Situations – it was launched to take stakes in similarly illiquid and long-term stocks, albeit in a very different market, and benefited from its closed-ended structure as a result; indeed the lacklustre performance of the fund over its first couple of years of trading could have caused real problems had it been an open-ended vehicle and had investors decided to cut their losses.

Other very large launches have included Mercury World Mining, almost 20 years ago, which has always had a mandate to invest in both raw commodities and unquoted businesses as well as blue-chip mining stocks. Similarly, Kleinwort European Privatisation and Mercury European Privatisation, which also raised hundreds of millions in the 1990s, were offering exposure in a relatively untested part of the equities market. All have needed the freedom to invest in potentially illiquid assets.

The clue is in the name of Woodford’s new investment company. This is a fund designed to reward patient capital – investors who are prepared to take a long-term view of businesses with the potential to generate outsized returns, rather than getting hung up on short-term lumpiness or distracted by changing sentiment.

In fact, this is not a bad way of thinking about the investment company sector as a whole. The very structure of closed-ended funds enables managers to have patience as they invest – and hopefully to reap the rewards of this restraint over time.