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The 10 qualities every great fund should have

05 April 2014

With the ISA deadline only a matter of hours away, FE Trustnet asks collectives specialist Ingenious to highlight what it looks for when picking a fund.

By Joshua Ausden,

Editor, FE Trustnet

A willingness to limit inflows and hold cash are among the key attributes all great funds should have, according to FE Alpha Manager Guy Bowles, who has compiled a 10 point check-list to identify leading portfolios.

ALT_TAG Bowles (pictured), a collectives specialist who heads up the Ingenious Global Growth fund, says there are only a handful of top quality fund managers available to retail investors, insisting that the vast majority have to rely on luck more than judgement.

“We’ve put together something called the 10 commandments, which gives us a method of screening funds for our portfolios,” he said.

“About four years ago we had a look around and realised there were only a handful of genuinely great funds. We counted five, and decided to look at what all the funds have in common.”

Bowles lists Invesco Perpetual High Income, formerly headed up by Neil Woodford, Angus Tulloch’s First State Asia Pacific Leaders fund, Sebastian Lyon’s Trojan fund, Veritas Global Equity Income and Findlay Park American as his top-five.

“This is our safety check. Not all of the funds have all of 10 attributes; for example, Invesco High Income actually has a long tail of holdings and so contradicts [point four].”

“However, in general there are 10 qualities that characterise the five funds.”

For those still searching for funds in time for the ISA deadline, this 10 point checklist may come in handy.


1. Focus on increasing wealth


While you’d imagine all fund managers aim to increase wealth, Bowles explains that generating returns and increasing wealth are different things.

“We like our managers to be fanatical about the downside,” he said. “The first question we ask ourselves is: ‘if I invest in this fund, could I lose everything?’”

“We’re managing people’s wealth, and so this is a key principle of what we look for.”

It’s telling that all five of the great funds Bowles refers to beat their sectors and benchmarks significantly in the 2008 downturn.

The Trojan fund was one of the standout performers; FE data shows it returned 1.11 per cent, compared to losses of 26.11 per cent from the IMA Flexible Investment sector average.


2. Have long-term horizons

The manager says he has no interest in managers who chase returns in the short-term, believing that this method of investing is a sure way to underperform.

He points out the funds he holds are often from boutique firms, as the managers tend to be given more leeway than those at bigger firms, who are under more pressure to deliver the goods in the short-term.


3. Unconstrained by market benchmark


“We want funds that can outperform – we’re looking for those with a high tracking error, which is the only way to justify your fee,” said Bowles.


4. Hold concentrated portfolios

Bowles says this point is very much linked to the third ‘commandment.’

“Fewer stocks show the manager has a high degree of conviction and permits substantial outperformance versus the benchmark,” explained Bowles.

The manager says Ingenious has compiled research looking at random combinations of funds, and found that there’s little merit in holding more than 30 stocks.

“When you get 22 to 23 stocks, the portfolio tends to have the same risk as the market. When you go high, the volatility doesn’t change but the tracking error comes down, basically meaning there’s a smaller chance of the manager outperforming.”



5. A willingness to hold cash

Bowles explains this is linked to a focus on protecting against the downside.

“I don’t want managers to invest in things for the sake of it,” he said.

Lyon currently has a 14 per cent cash position in his Trojan fund, reflecting his bearish stance.

Bowles says holding managers who are prepared to hold cash also means he doesn’t have to be as active with his own cash weighting.


6. A willingness to limit the size of their funds


“I don’t want the funds to be concerned about gathering assets. Everything should be about performance, whether that’s because liquidity is compromised, or

“In the case of Findlay Park and Trojan, limiting the size of the funds was more about managing the number of relationships they had. They wanted to spend more time running the funds and not seeing clients, and we welcome this.”


7. Concerned with business risk, not price risk

Again, this factor is associated with prioritising downside risk. Managers such as Tulloch and Veritas’ Andy Headley care more about the quality of the company in the long-term rather than the direction of its share price in the short-term.

Fundamental analysis is far more important to these managers than momentum, which is much more linked to short-term performance.


8. Significant personal investment

Bowles says one of the first questions he ever asks a fund manager is if they have their own money invested in the fund, as this ensures that their own interests are aligned with their clients’.

“It’s no coincidence that funds that have more of an emphasis on downside protection are those whose managers are self-invested,” he said.


9. Longevity of the manager/team


With the exception of Neil Woodford who recently departed Invesco Perpetual for Oakley Capital after more than 25 years at the firm, all five of the funds on Bowles’ list are run by managers who have been at their company for more than a decade.


10. Clear, unambiguous statement of investment objectives

The likes of Woodford and Tulloch have significantly underperformed their peers at certain points of the cycle, and at present Lyon is coming under severe pressure for nottaking part in the equity rally.

However, Bowles says he’s looking for managers who do not deter from their principles, regardless of the pressure being placed on them from external sources.

Ingenious Asset Management grew out of media company Ingenious in 2002. Bowles has run client money since 2003, and launched the £52m Global Growth fund into the retail space in March 2011.


The fund has made a very good start, outperforming its IMA Flexible Investment sector average and cash benchmark with returns of 16.66 per cent.

Performance of fund, sector and index since launch

ALT_TAG

Source: FE Analytics

Bowles has a particularly strong record in falling markets, protecting much better than his peers in the eurozone summer sell-off in 2011. This, he explains, is a result of the kinds of managers he holds.

“Given that we’ve taken the best attributes from those five funds, and think it makes sense for us to take on board some ourselves,” he said.

“Everything we buy for our clients we own personally one way or another ourselves, and we have a real emphasis on protecting on the way down.”

Returns have been less exciting in recent times, with the manager admitting that his fund is unlikely to keep up with the sector in fast rising markets. As with many of the managers Bowles holds, he says his priority is capital protecting, and beating his cash benchmark.

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