Fund management companies often make a big fuss about ‘star’ fund managers, like Fidelity’s Anthony Bolton (before he went to China), or Neil Woodford, who is currently all over the news.
You can see why. Managers who can consistently beat the market over a long period of time are vanishingly rare. If you can spot a future star early in their career, backing one is a great way to make money.
And of course, it’s also a great marketing tool for the fund management company.
Trouble is, as with any other industry, the star players often switch teams. Sometimes they get lured elsewhere by an enormous pay cheque. Or they strike out on their own – Woodford has just launched Woodford Investment Management with his own Woodford Equity Income fund.
So if you’re in a star manager’s fund and they switch companies, logic suggests you should move with them, right? After all, it’s their talent you’re interested in, not the fund itself.
Yet strangely enough, that may not be the right decision…
How funds perform when the star manager leaves
You see, research suggests that when a ‘star’ manager leaves a fund, chances are the fund will continue to outperform even after he leaves.
Pension company Aegon UK has evaluated the performance of 11 funds that were once run by stars who then moved elsewhere. Nine of these funds continued to beat their benchmark (the stock market index the fund is compared against) after the star manager had gone.
We won’t look at all 11 funds. But for example, Fidelity’s Special Situations fund beat its benchmark by an average 5.3% a year under Anthony Bolton from 1985 to 2008. After that, the performance did deteriorate – but it still beat the index by 1.9% a year.
And with a handful of the other funds, outperformance actually improved after the original star manager had left. On the whole, Aegon’s research suggests that on average, the ‘ex-star’ funds beat the market by 1.66% a year.
This matters. You see, the whole point of buying an actively-managed fund is that the manager promises to use their stock-picking skills to beat the market. Yet the majority fail to do so, despite the high fees you pay them for the privilege of trying.
So if you can find a fund that ‘works’, you should probably stick with it. Put it this way, if all the funds I’ve ever invested in beat the benchmark, I’d be a significantly richer man than I am now.
The question is: why do these funds keep outperforming even after the manager who made them successful has left?
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Aegon suggests a lot of it is down to culture. A fund isn’t all about one person. There may well be a team of analysts left behind who follow the same approach and style as their former boss. The departed star manager may even have trained up young talent who are ready to take over the reins.
Alternatively, sometimes a fund company may decide that the best way to ensure continued outperformance is simply to poach some top talent from a rival firm to take over the fund – in other words, replace a star with another star.
Three main lessons to learn from the quest for a star fund manager
There are three main lessons I’d take from this study. Firstly, this research is particularly relevant to anyone who owns units in the two Invesco Perpetual income funds that were run by Neil Woodford until recently.
I’m sure many of them have already moved their money to Woodford’s new fund. But if you still have money with Invesco Perpetual, I suggest you keep it there. Sure, Woodford has a great record. But Aegon’s research suggests you will still do pretty well with his successor, Mark Barnett.
I feel especially confident about Barnett because he also has a strong record managing some smaller income funds for Invesco Perpetual. In fact, as I noted in MoneyWeek magazine this week, on some measures Barnett is actually doing better than Woodford in terms of recent performance.
Secondly, as a rule of thumb, you should keep any chopping and changing of your investments to a minimum. I own some actively-managed funds, and I wouldn’t sell any of them just to follow the manager. I’ve bought these funds because of the strategy they follow or the sector they give me exposure to – and that won’t change just because the manager does.
Finally, this whole debate is just yet another demonstration of why you need a very good reason to opt for ‘active’ fund management over ‘passive’ funds, which simply track an index. The fact that so few fund managers can genuinely be described as ‘stars’ suggests that the odds of you getting lucky and finding one who can beat the market regularly are very slim.
Better to stick with cheap passive funds where possible – at least you know you’ll get the return on the market (less costs) rather than getting a nasty surprise the next time you look at your portfolio. My colleague Phil Oakley can show you how to build a complete portfolio using passive funds alone – find out more about his Lifetime Wealth strategy here.
• Lifetime Wealth is a regulated product issued by Fleet Street Publications Ltd. Your capital is at risk when you invest in shares, never risk more than you can afford to lose. Forecasts are not a reliable indicator of future results. Please seek independent financial advice if necessary. Fleet Street Publications Ltd. 0207 633 3600.
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