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Why I have sold my entire stakes in BP and Shell

Neil Woodford, the star fund manager, believes BP and Royal Dutch Shell may be forced to cut their dividends next year and has sold all his stake in the companies.

By Charlie Parker
Published: 3:23PM BST 08 Oct 2009

Mr Woodford is one of the most influential investors in Britain, managing £18bn in Invesco Perpetual Income and Invesco Perpetual High Income funds. He is also one of the most successful income investors over the long term, although his cautious approach made him miss much of the upswing in this summer’s rally.

So his decision to dispose of two major stakes, which had made up 8pc of his massive funds, swapping the money into pharmaceutical stocks, may give other income-seekers such as investors nearing retirement pause for thought. At a time when so much of the income on offer from British companies is focused on just a few stocks, Mr Woodford’s warning will be disquieting for investors who have heavily relied on the two for income portfolios.

Mr Woodford believes the oil businesses face significant headwinds as they seek to find new oil reserves at a reasonable cost and that the short-term economic conditions are such that oil prices could fall, making the companies’ dividends unsustainable.

He said: “Of course, these are companies that are affected by the global recession. But it is also getting increasingly expensive to find new oil and gas reserves and when you look at the cash-flow dynamics, you see that at the sort of oil prices we are now seeing, both Shell and BP fail to generate enough cash to cover both their capital expenditure and their dividends.”

Mr Woodford believes the global economy is set for prolonged weakness as consumer debt is repaid. He also says there is scant evidence that demand in the economy is recovering. This leads him to predict another possible period of weakness for oil prices.

He added: “If we are right about the economy, then oil prices will come under pressure next year. In the near-term I expect demand to remain weak. We will not see a V-shaped recovery or strong demand growth. So I don’t expect oil prices to be bouncing strongly and they may come down from the current $65-to-$70-a-barrel range. For these two companies to generate enough cash for capital expenditure and dividends, they need oil prices to rise significantly.

“But in the short to medium-term – the next one or two years – I think the oil companies will face some challenging decisions around what to do with their cash flows. They may well be happy to pay dividends from the balance sheet for a limited period of time, but they will not continue to do that and in my view they will face that choice next year. I’m not sure they will pay an uncovered dividend next year.”

Mr Woodford has spent 2009 with a cautiously positioned portfolio. It has hurt his short-term performance compared to peers as it has stopped him harnessing the stock market rally which has, he believes, been led by companies that are fundamentally unsound.

He believes, however, that the market will fall from its current levels: “The biggest challenge for me, I suppose, is holding my nerve. But I’m afraid you are condemned by your process and what you believe in, and you have to stick to those as a fund manager or you’ve got nothing to hold on to. I believe what I’m doing.”

The Invesco Perpetual Income fund is returning just under 6pc a year to date, compared to the 14pc returned by the average manager in the Investment Management Association (IMA) UK Equity Income & Growth sector. But Mr Woodford’s longer-term track record is exceptional. Over five years he is the top-ranked manager in his sector with a return of 59pc, more than double the average fund manager’s return of 25pc.

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