Should you follow fund managers?
On 1 May 2014, Neil Woodford officially joined Oakley Capital where, under the brand Neil Woodford Investment Management, he launched one of the UK's most hotly anticipated new funds: the CF Woodford Equity Income fund. Many investors – and many millions of pounds – have piled into the fund and are waiting to see if he can replicate his earlier success. Meanwhile, his former funds are haemorrhaging money.
Invesco Perpetual, where Woodford managed a massive £33 billion, saw half a billion pounds of outflows in a single day in January, according to data from FE Analytics. The once £14 billion behemoth Income fund he managed has shrunk to £6,989 million of assets, as investors question whether successor Mark Barnett can fill the star-studded shoes that Woodford left behind on Invesco's front doormat.
But should investors be so quick to flee? Should they loyally follow the manager who has produced impressive returns for them or trust that the strategy of the fund and the wider team contributing to it will prevail?
Risk vs reward
If you had followed the notorious Richard Pease around throughout his career from 1990 at Jupiter European, moving over to European Special Situations and then to Henderson, first on European Growth and latterly on European Special Situations, you would have been rewarded with a return of 2,800% on your initial investment, according to figures from Hargreaves Lansdown. In other words, an initial investment of £1,000 would be worth around £28,000 now.
A punt on Nigel Thomas when he started out at Artemis Capital in 1987 would have netted you a return of more than 3,500%, had you followed him to Axa Framlington UK Select Opportunities and stayed with him until now.
Opting to remain with those funds – Jupiter European and Artemis Capital – when their managers moved on to pastures new would still have netted you a decent return but neither has managed to match the success of its former manager. Since its 1986 inception, the Artemis fund has returned 2,358%, while the Jupiter fund has achieved a meaty 2,750% since its 1987 launch.
But can a manager truly take all of the credit for the success of a fund? Managers are typically supported by a huge network of analysts and researchers, so there are many moving parts that need to perform for the machine to function smoothly. Yet in an industry of around 2,500 funds available to retail investors, there must be a reason that a certain few individuals become stars.
"Some of these guys have exceptional track records. They have the conviction and the knowledge, and really the only thing that will stop them is retirement," says Adrian Lowcock, senior investment manager at Hargreaves Lansdown. But a lot of it is down to good breeding. "Most of them have come up through the ranks," he points out. "This gives them experience, ensures they have an analytical mind and that they know their market."
Gary Potter, head of multi-manager at F&C, says that while investors should not panic and follow their fund manager as a knee-jerk reaction, they should perhaps take heed and consider whether the departure is a warning signal. "Ask yourself why did they leave; is something not working at the business? There is usually more to it than just money. It can be an early warning about that company," he explains.
Or it could just be that the manager needs a new opportunity. The idea of running £33 billion of assets might sound like a fund manager's dream but in reality it severely limits the possible investment universe that the manager has available to him. Smaller companies become off limits and quick trades are ever more difficult. While investors pile money in to the successful manager's fund, its expanding size will eventually become a hindrance, points out Potter. "However good a captain is, the bigger the ship you put him on the harder it becomes to turn around."
Is it all about the manager?
But Alistair Thaw, director at Barclays Stockbrokers, thinks people put too much emphasis on the importance of fund managers.
"Investors care about returns. If a star fund manager is delivering, then maybe they will follow. But I think quite a lot of money follows consensus; people will look at the most popular funds and sectors [rather than the managers in question]," he explains.
He also thinks far more weight is put on the individual manager rather than the team as a whole, when the underlying resources and group ethic are a large part of the success of the fund.
"Do I actually think [star fund managers] make a difference? Probably not. They may have some good instincts but I think it is more a team effort and the infrastructure that is involved in that and the investment process," he says.
But Lowcock thinks this, too, is down to the manager. "We do not think it is the manager who comes up with all the ideas but he is able to digest a large amount of information and use that to construct a blended portfolio. A good team is critical too, and a good manager will build that team around them," he argues.
However, not even the best managers are immune to a change in fortune. Anthony Bolton is the most commonly cited recent example of where the tables have turned. Having successfully managed the Fidelity Special Situations fund from 1979 to 2007, producing an annualised return of 19.5% across that time, Bolton changed not only funds but regions, turning his attention from the UK to China. There he has not fared so well.
"But there is a lot more learning and understanding to be done [with that sort of move] that will take a bit longer," says Lowcock.
"Richard Buxton's move from Schroders to Old Mutual to run an almost identical fund is a much easier decision for investors to make."
This may be the "X factor" that has made Woodford's manoeuvre such a historic one. A man who has always had a penchant for smaller companies, Woodford had very limited access to these markets in his mega-funds but still produced some great returns. As he moves back to his favourite patch, no doubt investors are excited to see just what he can do now that a smaller fund will enable him to play in the shallower end of the pool again.
"This new fund will be smaller to start off with; Woodford can start again with a clean sheet of paper and buy what offers the best value at the time, and be more nimble," says Jeremy Le Seuer, managing director at 4 Shires Asset Management.
His advice to those who know they will follow the manager is: sell straightaway. If you wait to sell, shares will be less liquid and the bid offer spread may be larger. However, he cautions, Woodford had a significant period of "gardening leave" and those who took the decision to sell out of the Income fund immediately endured a long period out of the market at a time when markets were rising.
It's worth remembering that the star managers of today might not always be everyone's favourite. Their style could go out of favour, they might retire, or they might make a few poor decisions. Staying loyal is tempting, and doubtless there are a few individuals out there who can add real value time and time again. But, as the fund management industry so often warns, past performance is no guarantee of the future.
The rising stars
It's easy to spot the stars among the fund managers in the industry. They are the ones with decades of above-average returns, managing billions of pounds of investors' money. But spotting the next generation of stars is a rather more difficult task. How do you spot talent when it doesn't yet have the track record to prove its worth?
When perusing investment statistics to gauge whether a fund is worth your hard-earned money, the easiest thing to look for is, obviously, performance; a good long-term track record may only be a measure of the past but does give an indication of a manager's ability to generate returns consistently. In contrast, new managers may not have the all-important three-year history that so many people desire.
But Potter thinks it is important to look beyond such measures. "We want to get involved when a manager is creating that track record, not living off it," he says. "And indeed, we have been involved at an early stage when managers or funds have gone on to become household names. But spotting them is hard to do."
Andrew Wilson, head of investment at Towry, says a typical mistake made by investors is to choose funds at the top of the performance tables. "One cannot buy historic performance," he points out but he does admit that it is otherwise difficult to assess a fund manager with a short track record.
Darius McDermott, managing director at Chelsea Financial Services, says the past few years has been a "baptism of fire" for new fund managers. While some have been able to use the volatile environment to prove themselves more quickly than they might have in more docile markets, others will have quickly perished.
Wilson says that success in just one type of market is not enough; he wants to see evidence across the entire market cycle. "There are very few Warren Buffets or Neil Woodfords and, frustratingly, they cannot be identified in advance," he adds. "That is not to say that it is never worth backing a plausible manager with a sound process even if his track record is relatively short but rather that the chance of you being consistently successful in this is very small."
But some people do have other means at their disposal to try to find up-and-comers. Brokers and researchers have access to newcomer managers that the average retail investor does not, and most say a face-to-face meeting is an unparalleled tool in their armoury for being able to pick out a future winner.
"We like to meet managers and look them in the eye while they tell us about their investment process," says McDermott. "You can get a lot more face-to-face; you can see their enthusiasm, that they can articulate their process, and how they interact with different team members, and you can make sure they are confident, not arrogant."
Potter agrees that insider access to managers gives investors such as himself a real edge. "It's like Premiership teams that have scouts at smaller, non-league teams to find the next talent. The more resources you put into that, the more you will unearth," he says of his team of "scouts".
But he laments that it makes the landscape all the more difficult for the typical investor. "The trouble is that those investment companies that do have ability to advertise and get their name out there will get the investment. Private investors will never get to hear about some of the boutique firms [where we often find opportunities] because they just don't make themselves available," he explains.
Ben Yearsley, head of investment research at Charles Stanley, says that for private investors the ability to scout talent is limited. He recommends that investors look at a manager's history, and always look at discrete periods of performance to judge how they have performed over different time frames and in different economic conditions, rather than just looking at the overall cumulative number.
The individual personality of a manager can also encourage early investors that they will perform as they promise, Yearsley says. It's the same as when you meet a new partner in life, to an extent. They have to look a certain way on paper, and there are a certain number of boxes that have to be ticked but at the end of the day it's the feeling you get about them, and the belief that they can deliver.
Questions you should ask if a manager leaves your fund
1. How have they performed compared to their peer group?
While being top of the sector over every time period is not vital, if a manager is consistently mediocre they may not be worth following.
2. Why are they leaving?
If they are going elsewhere so they can run a mandate that allows them more freedom to invest as they want to, brilliant. But if their colleagues start to follow, it could be a sign of trouble at the firm.
3. Where are they going?
Is it a new fund group, and if so are you happy to take on the additional risk that comes with that? Has the fund group got a particular house style, and does that suit the manager's strategy?
4. What type of fund will they be running?
Running a similar fund will, hopefully, mean a similar strategy and continued strong performance. A major move from, say, developed to emerging markets could mean a steep learning curve and potentially lower returns.
5. How big will the fund be?
A smaller fund can allow managers to be more nimble and invest in smaller companies; a bigger fund may limit their possible investment universe.
6. Is it new or existing?
If the fund already exists, look at the history of the fund, why the manager is being replaced, the team already in place and how the new manager will fit into it. If it's a new fund, consider whether it fits into the range of the fund group and whether the group has the skill and resources to do a good job.
7. What is the strategy and will they be able to change it?
If the manager's approach is not aligned with the fund group's ethos or the fund's mandate, then it could signal problems on the horizon.
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.