Follow the trend to profit from funds

'Skin in the game'. Who has it and who hasn't? Every year, broker Collins Stewart produces a list of director and fund manager holdings in investment trusts. It does so because it thinks that investors should be able to take "material comfort" from the knowledge that those who manage our money have their interests aligned with ours. They pay the same fees as the rest of us (although they get some of it back in fee income and salaries) and they take our losses, as well as our gains.

This might not make them better at their jobs but at least it means they are with us, not against us.

And the good news is that investment trust directors of which I am one have significant skin in the game: a total of £687m this year.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

In fact, the directors and managers of some of my favourite trusts are going to feel some real pain if they make a mess of things over the next few years. Lord Rothchild has more than £200m in RIT Capital Partners; Jonathan Ruffer has £2m in the Ruffer Investment Company; Michael McPhee has £2.6m in Mid Wynd International; and Sebastian Lyon has more than £500,000 in Personal Assets Trust.

MoneyWeek videos

Why we like investment trusts

Investing in funds: why we prefer investment trusts to unit trusts.

For many other fund managers, the money in their funds doesn't have much of a connection to them: it's just another chip in the great bonus gamble. Not so with this lot. That's good and worth remembering when you are wondering which investment trusts to buy.

I was thinking about skin in the game when I met a man with a great deal of it earlier this week: Douglas Chadwick.

Chadwick is an old-fashioned entrepreneur. He left school at 14 to join the merchant navy (think six-week-round trawler trips to Iceland).

He later took a degree in theoretical physics and then made a fortune setting up flat-pack furniture companies. I tell him that I now understand why I am not able to put flat-pack furniture together.

He tells me I'm not trying hard enough. Either way, the point is that Chadwick has a history of self-sufficiency.

So when, having made his money, he deposited it with the financial services industry and found that the industry wasn't much good at preserving or increasing its value, he took it upon himself to find a better way.

Now he has a system of his own. I am not a great believer in investment systems (buy low, sell high seems to be the only thing that works in the long term) but Chadwick's timing in coming to see me was pretty good. Why? Because his system chimes nicely with what is turning out to be my theme for January: the idea that successful fund management is largely a function of luck.

A fund manager can occasionally be good at investing in one particular style or sector. But what he usually can't do is judge when that sector or style is going to be in or out of fashion, and shift to another one in time to maintain outperformance.

So, if you want to have a chance of doing well out of investing in funds, you need to capture not just skill but sector and style momentum. That's the tricky bit the bit that Chadwick and his colleagues address with an algorithm.

His website, www.saltydoginvestor.com, monitors thousands of unit trusts, rating them both within sectors and against other sectors.

The idea is then to see trends and to move money into them on the up and out on the down without overtrading or fussing too much about getting the top or the bottom exactly right.

Chadwick doesn't like to call it trend following or momentum investing. But that's basically what it is.

The industry isn't best impressed by this. It claims it will lead to overtrading (if you are thinking "kettles black" you aren't alone). It says that unit trusts aren't designed for this kind of thing.

And it thinks people are better off seeking professional advice than paying Chadwick's site £30 a month (soon to be cut to £20) for tips on fund trends.

It may, of course, turn out to be absolutely right. But momentum investing does have something of a happy history.

Jesse Livermore, the original momentum trader, made (and lost) two vast fortunes doing it and the story of the "turtle traders" 14 novice investors were trained to follow trends in two weeks in the early 1980s and made fortunes as a result is part of market legend, as well as the basis of the plot of the film Trading Places.

I also have a list of the very few funds around that have a history of more than 20 years and a compound annual return since inception of more than 20%.

They are almost all trend-following funds.

Chadwick's portfolio has done well so far (though obviously,this could easily be luck). But he also says he has £1.6m of his own money invested according to his system. That's real skin in the game.

This article was first published in the Financial Times.