Are fund managers the key to stellar returns?

Everyone wants to maximise the returns generated from their various investments but should they be concentrating on making asset allocation calls or relying on individual fund managers to deliver the goods in any environment?

It is a question that divides opinion. Andy Gadd, head of research at Lighthouse Group, is adamant it is the former. "The key to successful investing is establishing the correct asset allocation across different types of asset," he insists.

But Neil Mumford, principal of Milestone Wealth Management, is not so sure. He believes most retail investors aren't qualified to make such calls and suggests they are better off handing over responsibility to a fund manager.

"If you have a totally unconstrained fund manager who can look across all the asset classes then they will have more experience in deciding where a portfolio should be positioned at a particular time," he explains.

Making asset allocation calls

The danger in making asset allocation calls is getting it wrong. "Everyone knows you can't time the market so people need to use fund managers who will make these decisions on their behalf in order to take some risk off the table," he adds.

For example, putting all your money into equities just before a global recession hits would be a sure-fire way to lose every penny. Similarly, investing in safer areas, such as bonds, when the stockmarket is soaring means the potential for gains will be limited.

Asset allocation is an investment strategy, that aims to funnel a person's money into different areas, such as equities and bonds, according to the individual's goals, the length of time they want to be invested, and their attitude to risk.

Picking a fund manager

Those who concentrate on fund manager selection, meanwhile, put their faith in their reputation, the freedom they enjoy at the helm of their funds and their ability to deliver decent returns – usually illustrated by their past performance.

So which route is best? Unfortunately there is no easy answer. While some funds do well by having exposure to assets currently in favour, statistics show performances between rival managers operating in the same areas can vary enormously.

The average fund in the IMA UK Smaller Companies sector, for example, rose more than 50% in 2009 after having lost a staggering 40% the previous year, according to figures compiled by Morningstar.

However, the difference between the best and worst performers in the sector ranged from a relatively modest 5.52% increase by the CF Acuity Real Active Management fund, to the 246.87% increase by Close Special Situations.

Biggest performance driver

It is generally accepted that being in the right assets is the biggest performance driver, says Geoff Penrice, a financial adviser with Honister Partners, pointing out that equities was the place to be last year with the market rising 50%.

"The important factor was having exposure to the stockmarket – and the choice of shares became of secondary importance," he explains. "However, some fund managers can make money in a falling market so it is not always clear cut."

That said, it depends on where you are investing, says Ben Yearsley, investments manager at Hargreaves Lansdown, as even the industry's star managers will struggle to make headway if the market in which they invest turns against them.

"In an individual market such as the UK or Japan, the fund manager will be the most important factor but when you are talking about global investment themes it will be getting the asset allocation right – and that can be almost impossible," he says.

So where should you start?

Well, before worrying about asset allocation or fund manager selection, the first job is to set individual investment goals and ascertain attitude to risk, because these will influence the entire process.

What do you want to achieve by investing? Are you saving for a particular event – such as school fees – or is it part of your longer-term retirement planning? How long are you prepared to tie up the money?

It is pointless searching for a fund or manager until you know exactly what you are trying to achieve, according to Darius McDermott, managing director of Chelsea Financial Services.

Attitude to risk is also important. Do you want to play it safe in a stable fund that invests in investment grade corporate bonds or are you happy embracing the emerging markets and taking on more risk in the expectation of greater returns?

Asset allocation is all about choosing the investment products to which you want exposure. As well as the four main asset classes - equities (stocks and shares); bonds; property; and cash – there are also the likes of commodities and exchange traded funds.

Unfortunately it is virtually impossible to predict which of these will outperform in a given year, points out David Wells, head of pensions investments and savings at HSBC Bank, which is why canny investors have a mix in their portfolios.

"A portfolio of non-correlated assets, such as commodities, hedge funds, private equity, and property, in addition to equities and bonds, can give investors smoother returns over the market cycle," he explains.

Diversifying your investments

This concept of having a broad spread of assets is known as diversification, the idea being that losses in one part of your portfolio will be counterbalanced by increases elsewhere.

As well as being in different asset classes, diversification can also be achieved through exposure to different sectors and regions of the world.

Separately, you need to steer clear of trends. Particular funds may enjoy short-term periods of stunning outperformance, but these can just as quickly end. Opt instead for those with sound, longer-term investment goals that offer acceptable levels of risk.

Picking the right fund manager

Once you know where you want to be invested it is time to decide which manager in the asset class will receive your backing.

While past performance figures provide absolutely no indication of what will happen in the future, they still ought to be considered as part of your overall research – and require you to dig a little deeper into a proposition.

Has there been a recent manager change? Are the figures based on unusual market circumstances, such as the bursting of the tech bubble a decade ago? Is the reason for poor numbers due to problems in the sector? 

Then turn your attention to the managers themselves. Analyse their career track records to see if they have a long history of outperformance or whether they only come up with the goods in certain conditions?

You can do research at websites such as Trustnet, Morningstar and Interactive Investor.

Most investment houses also publish monthly fact sheets for each fund describing its aims and objectives, where it is positioned, and current themes.

Also take into account factors such as account charges. It is pointless opting for a fund with great returns, only to see it eaten into by performance-related fees.

What happens if the manager leaves?

An increasing number of managers have moved jobs in recent years and this can be very unsettling for both investors and their funds' performances so it is important to monitor your investments carefully during such a period. A manager's departure can have devastating consequences.

For some groups the exit of a star name can prompt dramatic action. When Neil Pegrum decided to join Cazenove less than 18 months after joining Insight Investment to launch the UK Dynamic fund, the company closed the fund.

However, a subsequent bout of underperformance does not necessarily mean that the replacement is not up to the job, points out Andy Gadd at Lighthouse Group.

"If a star manager departs then investors in his fund may sell their holdings to follow him and these outflows can make it very difficult for it to be managed properly."

So while it can be tempting to sell straight after a favoured manager heads for the door, it is worth considering your options. After all, you may find that the investment house replaces them with someone of equal – or even higher – stature.

It is clear that both asset allocation and fund manager selection should be important factors in your decision, whether you decide your own asset allocation or opt for a fund whose manager has the freedom to make the calls themselves.

Whatever you decide, the point is that you need to pick the right person to make investment decisions – and for them to be invested in the right areas, concludes Gadd.

"Once the appropriate asset allocation has been determined for a client's tolerance for risk, I then want a dedicated fund manager selecting appropriate funds or investments and monitoring these on an ongoing basis," he says.

Your Comments

I'm not sure that fund managers are worth all that much. So few of them actually beat the market. Asset allocation is mostly about acting on your attitude towards risk. Those who are more risk adverse will tilt towards bonds. If someone wants to diversify why don't they just buy index trackers from different markets around the world, that would provide both sector and geographic diversification.