Has the fund management industry become lazy?.
by Stephen Yiu

26 Nov 2018

 

The fund management industry has seen several challenges over the past few years, from RDR, to the active vs passive debate, and now a series of once ‘star’ fund managers delivering below-par results for their loyal fan base.

For financial professionals it is important to ensure that the best opportunities are available to your clients. However, highlighting these opportunities can be tricky, particularly when so many of the traditional processes of fund management have failed to deliver in recent years. 

Below we highlight some of the easy-to-spot signs that a fund manager could deliver market beating returns. We also provide some questions to ask your fund manager to help you ascertain whether a fund should be in your client’s portfolio.

The first and probably most important question to ask your fund manager is “what level of outperformance do you target?”. This might seem obvious, but it's an important question when you consider that the IA Global sector peer group has underperformed the MSCI World index over the past year. This isn’t because, as the press would have you believe, active managers are incapable of outperforming the index, it is because there are a lot of poor managers out there watering-down the average.

At Blue Whale we believe every active manager should be aiming to deliver at least 5% outperformance to justify their fees. This might seem like a lot, but it's only because the investment management industry has had to lower its expectations over recent years. The best managers, and therefore the managers you want to be putting in front of your clients, should be able to achieve this.

The first way an active manager can demonstrate their ability to outperform is by running a concentrated portfolio. This is for three reasons:

  1. Regardless of the manager’s ability, a portfolio with more than 35 stocks is statistically unlikely to deviate much form the index and is unlikely to deliver adequate performance.
  2. A smaller number of high conviction positions should indicate that the manager is only investing in their best ideas and not filling their portfolio with poorly researched stocks.
  3. Running a concentrated portfolio means each investment has the possibility of materially affecting the performance of the fund, thereby forcing the manager to agonise over its inclusion in the portfolio.

However, to run a concentrated portfolio successfully requires a great deal of research into each company. Research into a company is the most important element of fund management. But when you consider that many managers are acting alone, or with perhaps a single co-manager or analyst to generate ideas for the fund, you must question whether the research into each company is adequate.

To truly understand the companies, it is necessary for the investment team behind each fund to be far bigger than is currently frequently the case. Asking your manager about the size of the investment team should give you a good indicator of how well resourced the manager is.

It is because so many fund managers are under-resourced that they rely on two common practices within the fund management industry to try and demonstrate value – two practices that we are sceptical of at Blue Whale:

  1. Use of sell-side research
  2. Meeting with company management

We question the value of sell-side research due to its ubiquitous nature. How does this research allow a manager to gain an edge over the competition? MIFID II has highlighted the sheer number of managers using sell-side research. Unfortunately, the focus of this legislation was on the practice of how this was paid for and failed to generate the obvious question of ‘aren’t you doing your own research, and if not, why are we paying you a management fee?’ It should be noted that the price of research has plummeted since MIFID II, further indicating its limited value in company selection.

As for meeting with company management, it seems like a good way of demonstrating that the fund manager is doing their leg work. However, we question the importance of this. What can the managers of these companies really disclose? Is any of the information going to allow a manager to gain an edge – especially when disclosure of any information not in the public domain would be considered insider knowledge and illegal? How many fund managers have sat before company executives painting a rosy picture mere weeks before the company issues a profit warning or declares a poor set of numbers?

Everything we do at Blue Whale is laid on the foundation of in-house research. Our well-resourced and substantial investment team – currently comprising two fund managers and three full-time analysts all allocated to a single fund – allows us the confidence to run a concentrated, high conviction portfolio of 25-35 stocks. It gives us the time to research each company fully, in the hope that we can gain an edge over the competition; seeing those things that might lead to a re-rating of the stock price before others or highlighting potential headwinds so that we can alter our positions accordingly.

The research allows us to take a truly active approach - ensuring that our portfolio is only made up of those companies that we believe will deliver for our investors now.

As for diversification, our belief is that when you combine the best managers across the various sectors, running high-conviction portfolios, you will create for your clients a well-diversified portfolio of ‘best ideas’, demonstrating your ability to grow their wealth at a faster rate than the market in the good times, yet protecting their assets should the market fall back.

It is down to us to pick the best stocks in our asset class. It is down to the individual investor, or the adviser, to generate a portfolio of the funds, like ours, that can stand out in each sector.

 

 


 

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