Following the stars

Posted by Liz Rees in Weekly musings category on 29 Mar 19

The media loves to promote the cult of the ‘star manager’ but is it a worthy label or a burden that becomes impossible to live up to? This week I also look at why long-time favourite Neil Woodford has endured a difficult period and what we might learn from this.

What is a star manager?

These are high-profile fund managers with long track records in successfully executing a strategy and outperforming an index. They build their reputation on the back of a clearly defined, distinct and sometimes aggressive, investment style. Most are charismatic presenters who attract a following and, as a result, are likely to feature regularly in the financial pages.

Reaching for the stars

Try to remember that you are buying into a manager’s style rather than their personality. To achieve long-term outperformance, a fund’s holdings will look different to the benchmark (with a high active share) which means performance can deviate considerably from the benchmark. Therefore, even star fund managers should be expected to go through difficult periods.

Management style is an important aspect of diversification, so try to ensure your portfolio is not over-exposed to funds with the same style. This should help smooth out volatility as performance of a particular style can turn very quickly.

Why might a star fade?

Some investors are quick to rush for the exit at the first signs of a dip in performance. However, it’s probably worth taking a step back to investigate why a fund has slipped rather than act too hastily. In reality, it’s virtually impossible for a particular style, such as growth, quality or value, to perform well in all market conditions or stages of the economic cycle.

If the style is out of favour, which can last for some time, but the fund has done well relative to its peers it suggests the manager is doing the right thing and you may decide to ride out the period of weakness. It’s important to look forward and not just at recent performance.

Are the reasons why you bought in the first place still valid? If style is not the reason for underperformance, further questions to consider include: Have some key members of the team departed? Has it failed to stick to its process? Or, have misjudgements been made in sector and/or share selection?

One key thing to keep an eye on is if a manager leaves. We carried out some research, looking at a group of 15 funds where a ‘star’ manager has departed, and found that annualised average performance deteriorated during the tenure of the replacement manager.

Of most concern is a manager leaving for pastures new; if money follows them, the new manager may be forced to sell assets to meet redemptions, as well as needing time to implement his own strategy, particularly if an external recruit.

On the other hand, when a manager nears retirement, many funds will have a clear succession plan in place. For example, when Chris St. John replaced Nigel Thomas on AXA Framlington UK Select Opportunities, the duo had already worked closely together for many years.

Woodford Equity Income

A lot of investors followed Neil Woodford when he left Invesco to set up on his own. Their loyalty was rewarded for the first three years, with the fund delivering a healthy return, ahead of both its benchmark and sector. In the last two years, however, returns have disappointed, due to a number of factors.

Neil Woodford is a contrarian investor with a particular focus on valuation. This means the fund is concentrated in certain sectors and may have no holdings in others. Additionally, a positive stance on the unloved UK economy tilts the portfolio towards smaller, domestically-focused businesses. This has yet to reap rewards, due to Brexit uncertainty.

Mr Woodford openly admits he got some stocks wrong, with AA and Provident Financial issuing profit warnings and requiring further capital. Understandably, some will decide this is not good enough. Others will counter that any fund manager can have a spell of bad luck.

Woodford Equity Income invests up to 10% in small, high growth companies, some of which are unlisted. Concerns were expressed over whether illiquid, non-dividend paying assets are appropriate for an open-ended income fund. In response, the fund has exchanged a tranche of unlisted holdings for shares in Patient Capital Investment Trust, also managed by Woodford, which should improve liquidity.

Time to be bold?

Mr Woodford has stuck to his contrarian macro views and to give him credit is very transparent, publishing monthly a full list of holdings on his website. He remains confident that UK companies will adapt and thrive beyond Brexit, and that the economy is in better shape than people think.

During his 26-year career at Invesco, Woodford was nearly fired twice, for refusing to get involved in companies he believed were too expensive. He is adamant he will not change direction now and expects his contrarian style to ‘rebound spectacularly in the next couple of years’.

Who’s shining now?

Managers whose star has risen in recent years include Terry Smith of Fundsmith Equity and Nick Train of Lindsell Train UK Equity, though market conditions have suited their growth and quality styles.

Woodford is not the only contrarian to have had a testing time; Mark Barnett of Invesco Income UK, and Alastair Mundy of Invesco UK Special Situations have also suffered. Nevertheless, Mundy considers his hunting ground is ‘more attractive than it’s been for a decade’ while another well-known contrarian, Alex Wright of Fidelity Special Situations says it is ‘an exceptionally fertile period for contrarian stock picking.’

Even with a value style, the strategy adopted can have a different outcome. Henry Dixon’s Man GLG Undervalued Assets seeks companies with a positive catalyst for re-valuation and has a strict sell discipline when his price target is reached. This approach has worked well in recent years and Dixon manages Man GLG Income in the same way.

Remember that for a manager to outperform the market, he or she must invest differently to the market, so make sure you are comfortable with the risk of an investment. You can check out the risk and rating of a fund in :explore as well as using the fund search tool to find a list of funds awarded a gold, silver or bronze rating by Morningstar. These ratings are hard to achieve, demanding evidence of a disciplined and proven management process which has produced exceptional performance over an extended period.

Finally, ensure your portfolio is well-diversified and above all remember that successful investing requires patience.

Important Information: We do not give investment advice so you will need to decide if an investment is suitable for you. If you are unsure whether to invest, you should contact a financial adviser. 

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