What to look for in a good active fund manager

Big is not beautiful when it comes to investing in funds. Indeed, most big fund managers are constrained on multiple fronts. Here, Tim Price explains how to find a good active fund manager.

Stock Exchange Hanoi Vietnam

Big fund managers can't invest in Vietnam, but you can

ullstein bild - Schöning

John is out at the MoneyWeek Wealth Summit this morning, so today we have a guest essay from value fund manager and regular MoneyWeek contributor, Tim Price.

Are all asset classes expensive?

It's a complaint you hear often in today's low-yield world.

But it depends on where you look.

There's always opportunity lurking somewhere

Most institutional fund managers are constrained on multiple fronts.

They track some form of index or benchmark; that index or benchmark will almost invariably be market-relative (as opposed to absolute) in nature; they will have either very limited or no real discretion to limit the size of their funds.

Take Vietnam, one of our favourite markets. It's a favourite primarily on valuation grounds: its companies, while in many cases highly profitable and growing quickly, trade on a huge discount to those throughout the rest of the world.

It's also a favourite because of economic fundamentals. Vietnamese wage rates, for example, are roughly a third of those in China.

But Vietnam is also a favourite because of a technical wrinkle. By dint of being defined as a "frontier" economy (one step below that of an "emerging market"), Vietnam does not sit within the MSCI World Index it's not yet a developed economy.

But it doesn't sit within the MSCI Emerging Market Index either it's not yet deemed mature enough.

What this means is that if you're an institutional fund manager tracking either MSCI World or MSCI Emerging, you don't get to play in Vietnam. You're not allowed. You can't.

Well, we can because we're not constrained by a box marked MSCI or anything else. Hint: it will probably make more sense as a private investor to own Vietnam before the Big Boys are allowed in.

We have long stated that the only benchmark that should matter to any investor (private or otherwise) is an absolute return one.

That is to say, we believe more strongly in sustained capital preservation in real terms, than in more speculative capital growth that exposes client portfolios to huge swings in net asset value up and down.

Big is not beautiful when it comes to investing in funds

But perhaps the biggest impediment to investment performance is size. As Warren Buffett himself has acknowledged on numerous occasions, "size is the anchor of performance".

Asset management practitioners would provide a superior service to their clients if they limited inflows and concentrated on delivering investment returns. Sadly, the "institutional imperative" makes onerous demands on institutional players. In other words, it forces them to get greedy.

Given that the largest asset managers now control trillions of dollars by way of assets under management, investors in their funds might want to answer the following question using words of one syllable: can a market beat itself?

Before buying any fund, ask yourself some additional questions:

How big is it? The tree cannot grow to the sky. But try telling that to Neil Woodford, or to the average member of the Investment Association. Managers' pay is invariably linked to the size of funds under management. The more assets, the more pay.

It takes guts, and principles, to turn money away and concentrate solely on investment performance. But that's precisely what many smaller investment boutiques do on a regular basis.

Has the manager invested his own money? If he hasn't, why should you? Meaningful personal investment is by itself no guarantee of investment outperformance, but it shows the most basic alignment of interests between manager and investor.

Is it independent, and owner-managed? David Swensen, manager of Yale University's endowment fund, has gone on record saying he prefers the smaller, private partnership over the larger, listed full-service operator. How many mouths must your fees feed?

Is it an asset manager, or an asset gatherer? This gets to the heart of the challenge facing investors today. The investment world is polarised between asset managers, who focus their energies on delivering the best possible returns for their clients; and asset gatherers, who just want to maximise the number of clients. Most fund management firms fall into the latter category. Favour the former.

How to distinguish between the asset managers and the asset gatherers? Try to find managers like the celebrated investor Jean-Marie Eveillard, who once remarked: "I would rather lose half of my shareholders than half of my shareholders' money".

We conclude with three observations.

1. Homo economicus doesn't exist outside the economics textbooks. Private investors, together with their professional advisers and managers, may often be guilty of confusing "needs" with "wants".

When they say they "want" a certain annualised return, they might more accurately "need" the absolute preservation of their purchasing power over time and, ideally, some form of incremental positive return on top.

2. That size is the enemy of performance is the fund management industry's dirty little secret that hides in plain sight.

3. Index-relative investing is for the birds, despite the fact that almost the entire asset management industry pursues it. The essential truth of this statement will become almost tangible during the next market correction.

The truth is that there is no shortage of attractive investment opportunities in an unconstrained global marketplace. You just have to be looking for them. And most asset managers, as a direct and inevitable result of the hope, need and greed that drives their institutional imperatives, simply are not.

Tim Price is co-manager of the VT Price Value Portfolio and author of Investing Through the Looking Glass: A Rational Guide to Irrational Financial Markets.

Recommended

The building blocks for an income strategy: resilience, growth and diversification
Advertisement Feature

The building blocks for an income strategy: resilience, growth and diversification

Iain Pyle, Investment Manager, Shires Income plc
7 Jun 2023
Saving vs investing: which is better to help you make more money?
Personal finance

Saving vs investing: which is better to help you make more money?

Saving has become a more attractive option with interest rates hitting the highest levels seen in years, but if you’re prepared to take some risk inve…
7 Jun 2023
The top funds to invest in
Funds

The top funds to invest in

Investors continued to the passive preference throughout May, while high-yields were also sought. We look at the top funds, stocks and trusts that inv…
5 Jun 2023
£1.7bn sitting in unclaimed Child Trust Funds – here’s how to get the money back
Personal finance

£1.7bn sitting in unclaimed Child Trust Funds – here’s how to get the money back

Millions of pounds are sitting in languishing child trust funds. We look at how to track them down and how to make the most of your child’s savings.
22 May 2023

Most Popular

Best savings accounts – June 2023
Savings

Best savings accounts – June 2023

Interest rates have been creeping up - we look at the best savings accounts on the market right now.
6 Jun 2023
Nationwide to give £100 cash boost to customers
Personal finance

Nationwide to give £100 cash boost to customers

Nationwide Building Society is giving customers £100 as it reinvests profits. Dubbed the Nationwide Fairer Share scheme, we look at who is eligible.
22 May 2023
How much will it cost you to retire early?
Pensions

How much will it cost you to retire early?

The pre-state pension income gap means couples may need an extra £136,000 if they want to retire at 60 – can you afford to retire early?
6 Jun 2023