Fund performance vs Manager performance

elwy

The fashionable train of thought at the moment seems to be that manager performance is key when predicting which funds will perform best in the future. However as I look into the history of each manager I'm becoming a little bit wary of over-relying on manager performance.

Obviously if a fund has switched managers recently, then I agree the manager's past history might give a better insight into future performance than the fund itself. But on the other hand there are plenty of managers who run several funds simultaneously, often in drastically diverse sectors.

For example, is it fair to say that a manager who built up an excellent reputation managing funds in the Asia Pacific growth sector can be projected to do equally well when he takes on news funds in the European growth sector? How important is market familiarity versus general investing "skill"?

A few managers even have income and growth funds running simultaneously and I very much doubt that it is safe to assume they will perform identically well in both.

In these instances, I'd say that it might be more revealing to look at the fund's past performance, assuming that it has kept the same manager for a reasonable number of years. (I do realise that past good performance does not guarantee future good performance, but it's a starting point). Or in other words, it is wiser to apply a bit of common sense and check a manager's fund portfolio and history before blindly relying on ratings.

I might be stating the blindingly obvious or I might have missed the plot. Any thoughts? What key things do you look for when selecting an investment fund?

timarr

Over most periods nearly all active managers fail to beat whatever index is comparable to their fund. The rare exceptions like Peter Lynch are just that - exceptions.

The idea that manager performance is critical is simply another way of the investment industry trying to filch your money. In fact, in general, fund performance tends to mean revert - i.e. those funds that have performed worse in previous years are more likely (likely, not certain) to amongst the best performers in future years. Most managers simply add a layer of costs without adding any value and that's why most managed funds underperform index trackers. That doesn't even take into account survivorship bias where the worst managed funds are quietly wound up and disappear from the rankings.

So don't bother contributing 2.5% of your investment to an active fund manager's lifestyle, buy an index tracker and get it working for you, instead.

timarr

elwy

My personal aim is to develop a diversified, medium-high risk portfolio with an ex-UK bias. My idea of diversification is to have a mix of Global growth and value funds alongside a UK income fund, perhaps mixed with a balanced managed fund and bonds for risk management. I'm still researching the options available to me so this is merely an early idea of what I'd like my portfolio to look like, but I can't see how tracker funds will fit in or help me to achieve any of this.

It seems to me that there is an argument for using tracker funds if you have one particular style of investing; I've yet to be convinced that they are the answer to everything. Which brings me back to my original query; how best to choose the funds that will outperform?

timarr

The bottom line is: there is no way of knowing which funds will outperform. If there was everyone would do it and the value of the funds would rise to take account, removing any value premium. That's markets for you.

Anyway, no one can convince you apart from yourself but I'd suggest reading Burton Markiel's A Random Walk Down Wall Street or William Bernstein's Four Pillars of Investing before dismissing out of hand the idea that index trackers are a particular "style". The evidence that management fees damage returns is overwhelming and the compounded effect of losing 2.5% per year (average management fees) over long periods of time is huge.

Approximately (very approximately) index trackers returned 12% per year over the last 25 years, so taking that 2.5% into account a £1000 investment in 1984 would have been worth £17000 in indexers and only £9,600 in managed funds. BTW, 25 years is about the minimum safe period to invest in stocks due to their volatility.

Developing a global portfolio based on index trackers or ETF's is easy enough - the UK's nowhere near as developed in this respect as the US but there's still enough choice around to create a globally diversified portfolio, including government and corporate bonds, property and commodities if you see fit. Including some bonds is highly recommended - some new research due to be published by the index tracking analyst Rob Arnott suggests government bonds have now outperformed shares over every period since 1980 (although shares are in a trough and bonds in a bubble right now, so that's not as good as it might seem, IMO).

On value funds I'd suggest looking around for "fundmental indexing" - these are index trackers that are based on criteria other than market capitalisation for portfolio weighting. Bernstein and Malkiel suggest that value stocks can give 1% to 2% outperformance over standard indices and these vehicles aim to capture that increment. Again, over 25 years, that'd make a hell of a difference. Not much choice in the UK at the moment, but some noise that some of the big US indexers are looking at the UK.

However, if you want to invest in managed funds and you can figure out a way of differentiating between those managers who truly add value and those that don't I'd like to know, 'cos it'd make me rich.

timarr

Aegis

timarr wrote: »

The bottom line is: there is no way of knowing which funds will outperform. If there was everyone would do it and the value of the funds would rise to take account, removing any value premium. That's markets for you.

It's very unlikely that everyone would dive into funds identified as good performers. Even now there are arguments for and against active funds, trackers, absolute return, etc, and there are people who will still invest directly into bank managed funds with the highest level of charges despite the fact that they are almost always poor investments choices. Your interpretation of the efficient market hypothesis only works with funds when you assume that everyone is willing to do quite a bit of research to work out what's best, and also that what is best for one person will be best for all.

On top of that, most funds are open ended, so more people diving into them wouldn't directly increase the value of the funds. If the manager continued to push the new money into the existing assets, then yes, this would probably have quite an effect, but the manager can equally choose to invest the new money into different companies, smoothing out the effects of an increasing fund size.

Anyway, no one can convince you apart from yourself but I'd suggest reading Burton Markiel's A Random Walk Down Wall Street or William Bernstein's Four Pillars of Investing before dismissing out of hand the idea that index trackers are a particular "style". The evidence that management fees damage returns is overwhelming and the compounded effect of losing 2.5% per year (average management fees) over long periods of time is huge.

I don't know where your 2.5% figure comes from, but applying it to active funds now seems a little unusual given that none of my managed funds have a TER higher than 1.75% with management fees lower than that (and then some of those fees rebated to me on top of that, making it even better).

Once more, you're an example of someone focusing too much on the charges and not enough on the performance. Charges should be secondary to the overall performance. If you can find a fund which regularly outperforms the index and it has slightly higher charges, then as long as those charges are offset by the increased performance, the active fund wins out.

This is all ignoring the value that a fund manager can add over a tracker, including outperformance of the index in good years and defensive strategies in bad.

As a result of active management, my funds are almost all outperforming their various indices even in this climate.

Approximately (very approximately) index trackers returned 12% per year over the last 25 years, so taking that 2.5% into account a £1000 investment in 1984 would have been worth £17000 in indexers and only £9,600 in managed funds. BTW, 25 years is about the minimum safe period to invest in stocks due to their volatility.

Assuming that the managed funds performed exactly the same as the trackers before charges, your calculation would be valid. However, as this is not the case, it's not a fair comparison.

25 years is still not 100% safe, but it's a little excessive to say that it's the minimum safe period when 5-10 years would usually be fine for most purposes if you assume that we're not going to see a worldwide long-term depression. This is made safer still by phasing into and out of the market rather than investing or selling lump sums.

Developing a global portfolio based on index trackers or ETF's is easy enough - the UK's nowhere near as developed in this respect as the US but there's still enough choice around to create a globally diversified portfolio, including government and corporate bonds, property and commodities if you see fit. Including some bonds is highly recommended - some new research due to be published by the index tracking analyst Rob Arnott suggests government bonds have now outperformed shares over every period since 1980 (although shares are in a trough and bonds in a bubble right now, so that's not as good as it might seem, IMO).

On value funds I'd suggest looking around for "fundmental indexing" - these are index trackers that are based on criteria other than market capitalisation for portfolio weighting. Bernstein and Malkiel suggest that value stocks can give 1% to 2% outperformance over standard indices and these vehicles aim to capture that increment. Again, over 25 years, that'd make a hell of a difference. Not much choice in the UK at the moment, but some noise that some of the big US indexers are looking at the UK.

I'd quite like to look at ome better trackers than the UK has on offer at some point, as they might fill a niche that I have in my active portfolio. At present, however, I'd rather keep my money in sterling-denominated funds mainly for simplicity. Maybe when we start having more trackers here I'll take a look.

However, if you want to invest in managed funds and you can figure out a way of differentiating between those managers who truly add value and those that don't I'd like to know, 'cos it'd make me rich.

Ignore the bank managed funds and the passive managed funds and you've already eliminated most of the potential problems with active fund management. All you then have to do is find a management team that you think have good strategies and a history of beating the index in a variety of conditions, and you have a reasonable chance of continuing to do so.

timarr

Hi Aegis

Once more, you're an example of someone focusing too much on the charges and not enough on the performance. Charges should be secondary to the overall performance. If you can find a fund which regularly outperforms the index and it has slightly higher charges, then as long as those charges are offset by the increased performance, the active fund wins out.

That sounds like someone extrapolating from their own skills and experience to assume others can generally emulate their abilities. Many people can and for those that advice is fine, although they probably don't need to come on here and ask basic questions. Most people can't and suggesting that they can simply pushes them in a direction that'll do their returns damage in the long-term.

The argument about charges and returns really only applies in comparisons of active funds - there picking the fund on the basis of the lowest charge is simply stupid. The same, of course, applies in reverse to comparisons between index trackers where picking the lowest fee is the sensible option. In looking at comparions between active and passive funds you have to look at overall returns. There the research, going back to the Sandler report in 2002 shows that 75% of active funds underperform index trackers every year. Not only that but it's a different 75% every year so the subset of active funds beating index funds decreases over time.

Regardless of how good any research is it cannot guarantee whether or not any given fund will outperform an index. So an investment in an active fund is taking on excess risk over a tracker and any excess return you make is a consequence of accepting that risk. So, of course, is any loss. If the return on an index tracker will see you achieve what you need to then taking a risk on the former is just plain silly. If it isn't, well, your research needs to extend well beyond asking opinions here.

You're correct of course that ten years is normally enough to mitigate most stockmarket risk. It's just unfortunate that the last ten years is not one of those normal decades ...

timarr

elwy

I appreciate the viewpoints on trackers vs managed but that's already been argued many times elsewhere, I was rather hoping for some discussion and tip-sharing around what key features you consider important when choosing managed funds.