Last week, late on Monday evening Neil Woodford’s flagship fund, the LF Woodford Equity Income fund, was suspended with immediate effect. Whilst Woodford looks to restructure the fund, investor’s money will be trapped inside until it reopens. This week’s email isn’t to address the specific issues of Woodford’s fund but instead to look at the lessons we all need to learn from the events that led to this sorry situation and to consider what to look out for when choosing a fund.
The mantra that past performance is not a guide to the future is used widely across the industry and for good reason. Past performance does not tell you much about what is going to happen in the future. Future performance will differ for a number of reasons, markets as a whole might perform differently, a fund managers style might fall out of favour or the fund manager themselves may have changed their investment approach or gone off the boil.
Past performance is useful information but needs to be taken in context and especially in relation to what the fund manager is doing.
Fund managers tend to find a niche. An approach and strategy that they feel comfortable operating in. As a result, the day-to-day strategy doesn’t change, and fund management becomes quite a repetitive job. Of course, all good fund managers can and should fine tune their approach as they learn from mistakes and markets evolve, but when a manager changes their investment style this should at least raise some questions. Does the manager have the skills to invest in the new style? Does the fund still have a place in your portfolio?
Investments in a portfolio change all the time, some more than others. For example Nick Train, Manager of the Lindsell Train Global Equity fund and UK Equity fund, famously likes to buy and hold stocks for a long time. Other managers however will constantly alter their portfolio, tweaking and changing investments, such as Henry Dixon manager of the Man GLG Undervalued Assets funds. This is fine as it is in keeping with each investment style but it does mean that investors (and analysts) need to keep an eye on things. We need to make sure the portfolio is still structured in a way which reflects their investment style. So, if a fund goes from investing in large companies to focusing on smaller companies we need to ask questions. Is the manager sticking to their investment philosophy and process? Is the fund riskier and does it still meet your objectives?
We believe diversification is critical to successful long-term investing and the recent events of Woodford Equity Income fund are a reminder of why it is important. If you have only a small proportion of your money invested in the fund the suspension is not great news but ultimately it is likely to be more manageable. You can still get access to the rest of your portfolio if you need cash in the short-term.
Diversification is about the fact that no-one has a crystal ball and that past performance is a poor guide to the future. A balanced portfolio will help protect you from the effects of periods of poor performance in one fund or falling stock markets. Usually another area or asset class will be doing better, to compensate and smooth out the volatility of stock markets. In recent years we have seen that the growth style has been doing well whilst value and income funds have struggled. This may well change in the future.
Choose the right vehicle
Open-ended funds are suited to highly-liquid investments like shares traded on major stock exchanges. However, they are often not the best option for investments like property and unquoted shares as it is not always possible to quickly find a buyer for these illiquid assets at sensible prices.
The rules for most open-ended funds allow them to hold up to 10% in unlisted investments. This does not sound like a lot, but when you have money flowing out of the fund quickly and it takes time to sell your illiquid investments you can very quickly get on the wrong side of the rules.
Investment trusts don’t have this problem as the buying and selling of shares doesn’t affect the amount of money held in the trust. As a result, large sales of the investment trust’s shares don’t result in the manager having to sell the underlying assets.
If a fund’s objectives or structure materially change and end up significantly different from what you thought you had invested in, then this should be cause for concern. Whether or not the manager maintains a good track record is not relevant as the reasons you originally invested in the fund have disappeared. The investment may no longer match your goals.
Keep it simple
The final lesson we will cover off here is that it is easy to overcomplicate investing and to try too hard. The key is to keep it simple. Some of the best fund managers are those that have their investment philosophy memorised and can explain it in a matter of minutes (or at least demonstrate they understand it). You don’t need to be an investment expert to understand it either. Manager’s skill is not solely in their philosophy, it is also in the execution of it. The ability to find companies that meet their criteria and to stick to their investment process.
Fund managers are often viewed as maverick or heroic investors, who like to take risks but the truth is so much more mundane. A good fund manager will often spend hours each day reading the latest research and analysis on potential investments. The job is very detailed and fund managers need a lot of patience as choosing to do nothing is often the right course of action, doing so however often takes a lot of work.
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