Are your companies living on borrowed time?

It’s worth doing an audit…

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

It’s remarkable how clever people can be… after the event.
 
Take the industry-rocking misfortunes of fund manager Neil Woodford.
 
As anyone keen enough to get emails from the Motley Fool must know – because even my mum has an opinion, and she’s allergic to investing news – Britain’s most famous fund manager suspended his flagship Woodford Equity Income Fund earlier this month.
 
The problem? Woodford’s fund has been doing poorly, and investors have been asking for their money back.
 
So far, so everyday in the world of hot-or-not funds… except here there was a snag, and it was getting worse.
 
Woodford could not raise capital quickly enough to meet the demands of his departing investors. He’d invested too much capital into less liquid and unquoted companies, and those take time to sell for a good price. The increasing clamour for cash brought the fund ever closer to a value-destroying fire sale.
 
So Woodford suspended trading and said investors who wanted out would have to wait.

Can’t sell, won’t sell

You’ve probably read plenty of articles dissecting the Woodford blow-up. Most explain the tension inherent with holding investments with a very long time horizon such as stakes in unquoted start-ups in a fund such as Woodford’s that offers daily liquidity.
 
I’ve read a dozen describing the mismatch as an accident waiting to happen. I could have read more, but by the thirteenth they become rather predictable.
 
But here’s the thing – I don’t recall anyone warning about this a few years ago when Woodford was in the ascendant and his fund managed more than £10bn!
 
The unquoted and illiquid holdings were in the fund then, too. But few batted an eyelid.
 
Don’t get me wrong: I agree illiquid shares don’t belong in this fund. Investments like that are better held in an investment trust, where the manager does not need to sell them if shareholders want their money out.
 
But until the last few months – when the headaches caused by his unquoted holdings and the attempts to address them became too obvious to ignore – even Woodford’s critics mostly bemoaned his market-lagging stock picks.
 
It’s only after the fund’s suspension – which more or less nobody predicted – that everyone apparently foresaw how matters would come to a head!

Someone told you so

Economists have a name for this: hindsight bias.
 
Hindsight bias is the misconception we have that we always knew something was going to happen only after it does so.
 
At least a stock market keeps score. The honesty box of our portfolio’s returns can give us pause to ask whether we really were so prescient, given we’re not yet as rich as Warren Buffett.
 
Yet we shouldn’t be too hard on ourselves – because it’s only sensible for us not to heed every warning. The stock market is a place where someone screams the sky is falling every day. If you traded your portfolio on the back of all these worries, the only one who’d end up rich would be your broker.
 
Yet I believe it’s worth checking over your portfolio now and then to ensure you’ve not grown too comfortable with risks you’re vaguely aware of – but that one day you might be reading were apparently ‘no-brainer’ warning signs after it all goes wrong.

Will they or won’t they?

To start you off, here are four clear – and yet widely ignored – concerns to consider.
 
Oil companies and climate change – It’s almost universally agreed amongst scientists that the burning of fossil fuels by humans has warmed the planet. The debate is now on what we should do about it. Calls to halt the use of coal, oil, and even gas are no longer voices on the fringe – even the Bank of England has warned so-called ‘stranded assets’ amounting to trillions in fossil fuels that cannot be burned could threaten financial stability. Yet private and institutional investors alike happily buy Royal Dutch Shell (LSE: RDSB) and BP (LSE: BP) without thought for much more than their high dividend yields. Why are they high, eh? And when will something give?
 
Housebuilders and Help to Buy – Britain’s listed homebuilders paid out £2.3bn in dividends last year. Only a decade after the devastating financial crisis, they’ve become cash fountains. Yet critics argue the government’s Help to Buy subsidy that is meant to boost home ownership among the young has only really boosted builders’ profits. They say it’s led to higher prices that have fattened margins without even encouraging home construction. Help to Buy is due to end in 2023. Will the boom stop with a bang – and will everyone say they saw it coming?
 
Abandonment of household brands – For many decades there was a simple game plan when it came to selling everyday consumer goods: Create or buy a big brand, spend heavily to promote it, squeeze rivals off the shelves, and then sit back and enjoy the margins that come with selling 20p tubs of something or other for ten times that. In recent years though, the wheels have come off the model. Young shoppers aren’t half as loyal about brands, and they’re happy to try upstarts (think craft beer). Cutthroat competition in the austerity years made it more acceptable to hunt for cheaper options (think Lidl and Aldi). And retailers have watched what sells best and then created their own-label alternatives (think Tesco and Amazon). Yet despite all this, the likes of Unilever (LSE: ULVR) and Diageo (LSE: DGE) have rarely been so highly-prized. Are their high valuations the final dazzle of a bright sun that’s about to be extinguished?
 
Open-ended property funds – Last and least ambiguously, the gating of Woodford’s income fund is hardly unprecedented – we’ve seen it done twice before in the past decade or so by property funds. These funds own expensive and laborious-to-sell buildings, yet their investors can cash out on a whim. That’s okay in normal times, because the funds hold a cash reserve to meet such redemptions. But when panic sets in – such as after the UK voted to leave the EU and in the midst of the financial crisis – the buffer is exhausted and the funds are unable to sell property overnight to raise more money. You’d think we’d know better by now – indeed I don’t understand why the regulator doesn’t force such firms to convert into investment trusts to avoid the issue – but no doubt we’ll hear more about that when property next goes into a tailspin.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

The Motley Fool UK has recommended Diageo and Unilever. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro.

More on Investing Articles

Investing Articles

How much would I need to invest in income shares to earn £300 a month?

What kind of lump sum would be required to earn £300 a month by taking advantage of some of the…

Read more »

Investing For Beginners

Up 31% in a month, could this FTSE 250 stock be getting bought out?

Jon Smith takes a look at speculation that's pushing the share price of a FTSE 250 share higher and considers…

Read more »

Investing Articles

Here’s how I’d follow Warren Buffett to start building passive income in 2025

Ben McPoland highlights one FTSE 250 firm with a strong competitive edge that he thinks can continue rewarding investors with…

Read more »

Investing Articles

Burberry shares: undervalued FTSE gems that are ready to rocket?

Burberry shares soared at the beginning of the week as the takeover rumour mill went into overdrive. Is Paul Summers…

Read more »

US Stock

Here are the latest share price forecasts for S&P 500 giant Amazon

Amazon has generated monster gains for investors over the last decade. And Wall Street analysts believe the S&P 500 stock…

Read more »

Man writing 'now' having crossed out 'later', 'tomorrow' and 'next week'
Investing Articles

2 high-yield FTSE 250 shares I’d buy today — and 1 that I’d avoid

UK markets have felt some volatility after last week’s Budget and the FTSE 250 was no stranger to it. Our…

Read more »

Investing Articles

3 reasons the Rolls-Royce share price could soar over the next decade

Sustainable aviation fuel, narrow-body aircraft, and small nuclear reactors could all keep the Rolls-Royce share price climbing over the next…

Read more »

British flag, Big Ben, Houses of Parliament and British flag composition
Investing Articles

Here’s how much income I’d get if I invested my entire £20k ISA in cheap BT shares

BT shares are on the up but still cheap, while the FTSE 100 telecoms stock offers a good yield too.…

Read more »