Finding out what lies at the heart of a fund manager’s success is the key to yours, says David C Stevenson.
In recent years we’ve seen massive growth in flexible funds. These aim to preserve some (if not most) of your capital in bear markets, and to deliver some of the upside in bull markets.
The funds tend to attract a lot of money – they’re usually built around a personality or brand, and incorporate a load of quantitative strategies alongside a few inspired central asset-allocation ‘calls’ – big, headline-grabbing bets that pay off for investors when they’re most needed.
But which of these funds are actually any good? There’s a lively debate going on about what exactly lies at the heart of some fund managers’ successes. This matters.
When I look at money flows, it seems clear that most of the money that gets invested into funds that have proved successful in the past, could generously be described as ‘hopeful ex-post’ money – investors largely stick their money into a fund after the event (a big bear market call that paid off, say) that got it defined as ‘successful’ in the first place.
Trouble is, if the manager has just got lucky, then these new investors will end up being disappointed – they’ve missed the brief period of glory and face a future of disappointing returns.
I’d argue that there are basically two kinds of persistently successful manager: the ‘hardy all-rounder’, and the ‘patient contrarian’. And it’s vital to know which you are getting before you invest.
Two successful styles
Let’s assume most active fund managers worth investing with are taking big bets against the wider market. After all, if they don’t, they are just running closet tracker funds – and we don’t pay them their fat management fees to do that! Every so often, these bets pay off for the ‘patient contrarians’, and the market proves them right in their conviction trades.
But in between there can be long periods of merely decent returns. Ranged against the contrarians are the near-mythical ‘hardy all-rounders’, whose skills let them smoothly navigate all types of markets.
Which would you prefer? The contrarians can make super-sized returns that more than compensate for any underperforming years. The all-rounders provide a blended return that may be a little unexciting, but they just keep compounding away. So there’s no right or wrong answer – but wouldn’t it be nice to know which kind of manager you’re handing your money to?
That’s the challenge set by a cracking little paper called One Hit Wonders? by money managers Roland Meerdter of Propinquity Advisors and Steve Goldin of Parala.
The pair are interested in leading fund managers. The paper alights on a great example: French-based Carmignac Patrimoine, which also featured in a MoneyWeek piece I wrote in January, as part of my own research into fund-manager consistency.
I looked at how personality-driven funds (usually with veteran managers) pull in vast amounts of capital. These veterans have both good and bad years – the key is to bear in mind the longer track record, and ride out bad times to get to the good.
Meerdter and Goldin take a slightly different tack. They look at the “drivers of a fund manager’s track record”, ie, how the manager navigates constantly changing environments. Or as they put it: “does the manager have the ability to continue producing strong performance as the investment environment evolves?”
They argue this is very relevant as markets go through ‘major shifts’, and is even more important when a manager has a year or two of impressive returns. Is the manager getting lucky because the environment suits their style? Or are they able to shift tactics as the market changes?
Contrarianism delivers the goods
Carmignac’s success in the global financial crisis shows how a contrarian fund manager can deliver the goods when the markets go their way.
The Patrimoine fund shot ahead of its peers because the manager Édouard Carmignac saw the crisis coming, and so had “a near-perfect positioning for a perfect storm”, reckon Meerdter and Goldin.
To examine these factors more systematically, the authors focused on how a manager responds to changes in big macro-economic numbers – such as rising volatility, or increases in the default spread between risky and not-so-risky debt.
In Carmignac’s case, because he was “exposed to high quality” assets and “limited exposure to credit and its risks, he was able to greatly outperform”.
So far, so good. But what happened after this big success? The paper looks at the Patrimoine fund’s underperformance for the years 2010 and 2014.
It asks whether those “prescient skills pre-credit crisis [are] not adapting to the changing economic conditions post-credit crisis, coupled with the credit crisis itself being a singular event that decimated many portfolio managers” (which made anyone still standing after the fact look even more impressive relative to their peers).
The optimist would argue that the Carmignac fund has been underperforming because it is now positioning itself for future once-in-a-generation opportunities – which are more common than we think. The cynic might suggest the manager was just lucky.
This debate might sound arcane – but it isn’t. It really matters if you are going to rely heavily on one active, successful manager. You need to understand what you are buying into. My view is that while its recent numbers have hardly set the world alight, the Carmignac Patrimoine fund is no one-hit wonder.
The group’s record in the 1990s of spotting the growing importance of emerging markets, for example, shows that its clever positioning ahead of the global financial crisis was far more than one lucky hit. So if there are any similar big blow-ups in the future, as a ‘patient contrarian’, the Patrimoine fund could be well-placed.
But who are the hardy all-rounders? I set that challenge to Parala’s Goldin and he suggested two funds that stand out as steady performers. According to Goldin, M&G’s Optimal Income scores highly “through its multi-sector fixed income exposure combined with small equity bets”.
The fund “also adds value by getting its macro exposures right, which probably comes from good bond sector allocations as well as equity income allocations”.
Goldin also rates Jupiter’s Merlin Balanced fund. This fund wins out “through a lot of equity beta and some prudent alternative asset allocation bets the other way”. In other words, it has exposure to the broad stock market, but this is hedged with exposure to other asset classes that should benefit if stocks are having a hard time.
Runners up in Goldin’s analysis include Neptune Global Alpha, which is “a pure equity alpha play where the manager had demonstrated good skills since 2009”.
He also likes MoneyWeek favourite CF Ruffer’s Total Return fund where the “manager has demonstrated a good combination of top down, macro skills and lesser albeit positive stock selection skills which has made this fund a decent choice”.