Some money managers are very good at what they do. Some money managers are just plain unlucky. Some don’t try hard enough. And there are some who, to put it bluntly, are simply not up to scratch. To decide which category a fund manager belongs to is not easy, especially if you do not have long enough a track record to judge their performance on. How good is good? Take Anthony Bolton as an example. Bolton made a name for himself when his Fidelity Special Situations Fund delivered a 20% annual return over a 25-year period. Over the same…
To decide which category a fund manager belongs to is not easy, especially if you do not have long enough a track record to judge their performance on.
How good is good?
Take Anthony Bolton as an example. Bolton made a name for himself when his Fidelity Special Situations Fund delivered a 20% annual return over a 25-year period. Over the same time span, the benchmark FTSE All-Share Index returned just 7.7%.
Does that make Bolton an outstanding money manager?
It does, in my book. But we also need to remember that there were long periods when his fund underperformed the market. That could have prompted some investors to throw in the towel, which could have been a costly mistake over the long haul.
A cut above the rest
Neil Woodford is another who is a cut above the rest. His outstanding performance will probably be highlighted by generations of investors to come. Over a 15 year period, Woodford’s Invesco income funds delivered returns of over 300%. The market only delivered about 40%.
That is quite a margin of outperformance. But we mustn’t ignore what happened during the huge market rebound in 2009 and 2010. Over those two years, the market jumped 30% and 15%, respectively. Meanwhile, Woodford’s funds improved around 10% a year.
The point is that investors and fund managers should not expect above average market returns year-in, year-out. That is unless we invest through an index tracker, in which case we will always get the market return. Stock picking carries risk and not even legendary investor Warren Buffett can claim to have beaten the market every year.
The best stocks to back
A recent report by a UK online fund platform highlighted the perils of stock picking. It exposed funds that have underperformed for three consecutive years by more than 10% over the three years. It flagged up M&G as one of the underperformers with three funds in the spotlight. None of M&G’s funds underperformed in the previous report.
The fact that investments can perform well one year and underperform the next is not unusual.
One of Asia’s star fund managers, Hugh Young from Aberdeen Asset Management, recently commented on the underperformance of some of his company’s funds that have exposure to emerging markets. He defended the funds by claiming that Aberdeen’s emphasis on quality companies with predictable earnings worked against them last year.
Some of Aberdeen’s top holdings in its Singapore Equity Fund include Oversea-Chinese Banking Corporation (SGX: O39), Keppel Corporation (SGX: BN4) and DBS Group (SGX: D05). Also in the portfolio are UOB (SGX: U11) and Jardine Strategic Holdings (SGX: J37).
He said that these stocks are the best to back over the long term. He even added that fund managers who promise to outperform every year are kidding themselves and investors.
Interestingly, it is possible to scrutinise the ways that professional money managers look after other people’s money. A popular, though by no means fool-proof, method is to look at how much risk a taken by a fund to achieve its returns.
Risk in this instance is measured by how volatile the returns have been in the past. So, a portfolio whose excess returns, over and above risk-free Gilts or Treasuries, that are less volatile could be viewed as being better than another whose returns are more risky.
The risk-adjusted measure of fund performance, which was developed by William Sharpe in the 1960s, is widely reported. It helps us differentiate between different money managers. From an investor’s perspective, the higher the Sharpe ratio, the better should be the quality of the returns. That is because the excess return has been achieved by taken on proportionately less risk.
Counting the cost
It is worth pointing out that some fund managers might not underperform the market as a result of their poor choice of investments. They underperform because of charges that are incurred through management fees and also expenses that are paid as a result of trading excessively, otherwise known as churning. These charges inevitable eat into the total return.
But here is something to consider. A recent study was carried out on Warren Buffett’s Berkshire Hathaway investment portfolio to determine how he has managed to outperform the market by so much and for so long.
Learning from the master
It was found that Buffett’s Sharpe ratio was almost double that of the overall stock market and better than the average for mutual funds over the last 30 years. Put another way, he did not take on excessive risk to achieve his stellar performance.
Instead, his outperformance came from, amongst other things, investing in businesses with stable and predictable earnings; buying into companies with high margins and purchasing stocks that are cheap compared to their book value.
In other words, it is not rocket science. It is also something that we can do for ourselves. So, the best fund manager for your money could be you.
A version of this article first appeared in the Independent on Sunday.
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