The major reason why investor can never really expect their fund manager to continually outperform is because investment styles will fall in and out of favour during the course of a market cycle.
That’s not to say certain managers haven’t demonstrated a very high level of consistent outperformance over recent years, however, and Martin Cholwill and Nick Train have been very good examples.
According to FE Analytics, Cholwill’s £1.5bn Royal London UK Equity Income fund and FE Alpha Manager Train’s CF Lindsell Train UK Equity fund – both of which are five crown-rated – have both outperformed their respective IMA sectors in each of the last six calendar years – and are on course to outperform again in 2014.
Source: FE Analytics
Train has beaten the FTSE All Share in each of those years, while Cholwill has outperformed the index in all but one of them.
Though it would be naïve to think the managers will keep up that level of outperformance forever, the fact the period in question includes strongly rising markets like 2013 and plummeting markets like 2008 demonstrates just how impressive their track records have been.
Train (pictured) launched his now £1.1bn fund in July 2006.
Our data shows that though its returns of 2.24 per cent in 2007 were lower than the FTSE All Share’s gains, it outperformed the IMA UK All Companies sector average that year. Since then, it has been the only portfolio – out of the 229 funds in the sector which have a long enough track record – to boast top quartile returns and to have beaten the index in 2008, 2009, 2010, 2011, 2012 and 2013.
Though it has struggled relative to the sector and its benchmark at points over the last 10 months or so, it is currently top quartile in 2014 and is beating the All Share.
Since its launch, CF Lindsell Train UK Equity has been a top decile performer with returns of 155.01 per cent, beating the FTSE All Share by close to 100 percentage points in the process.
Performance of fund versus sector and index since Jul 2006
Source: FE Analytics
It has also been top quartile for its annualised volatility, Sharpe ratio, which calculates risk adjusted returns, and maximum drawdown, which measures how much an investor would have lost if they bought and sold at the worst possible time, over that period.
Train runs a highly concentrated portfolio of around 25 to 30 stocks, which tend to be high quality, durable and cash-generative business franchises. He is willing to take punchy off-benchmark positions within his fund and has very low turnover.
His top 10 holdings account for 70 per cent of his total assets while individual positions like Unilever, Diageo and Reed Elsevier each make up more than 8 per cent of the fund.
Given that he is willing to ignore the index, it will come as little surprise that his fund has been top decile for its alpha generation, relative to its benchmark.
Though Train has performed well, he is aware that it is unlikely to continue without end.
Speaking at his Finsbury Growth & Income Investment Trust – which is a mirror image of his open-ended fund – AGM in October 2013, he warned investors that tougher times lay ahead.
"It re-emphasises what I have been saying to shareholders. I have been flabbergasted by how much this trust has outperformed, but investors should realise that this will not go on forever," Train said.
That hasn’t been the case yet, leading FE Research and Square Mile, the investment consultancy, to conclude that Train’s past performance has been down to more than just blind luck.
Square Mile has awarded CF Lindsell Train UK Equity with its highest ‘AAA’ rating, while it sits on the FE Select 100 due to the manager’s clear cut stock-picking style. FE Research’s Charles Younes explains what investors can expect from the portfolio in the future.
“The portfolio should remain almost unchanged as Train hardly ever sells stocks on short-term news flow,” Younes said.
“It will only occur if one company loses its long-term competitive advantage. The portfolio is expected to be able to protect investors’ capital in falling markets due to its focus on industry leaders.”
He added: “On the flip-side, it will underperform when the market is driven by companies whose revenues depend heavily on economic growth.”
CF Lindsell UK Equity has a yield of 2.34 per cent and an ongoing charges figure (OCF) of 0.77 per cent.
Cholwill (pictured) took over the Royal London UK Equity Income fund, which is also a member of the FE Select 100, in March 2005.
According to FE Analytics, it has been the third best performing portfolio in the IMA UK Equity Income sector over that time with returns of 147.55 per cent, beating the FTSE All Share’s gains by 47.67 percentage points. Performance of fund versus sector and index since Mar 2005
Source: FE Analytics
The fund has outperformed the sector average in every year that Cholwill has been at the helm and has beaten the index in all but two of them, which was in 2007, like CF Lindsell Train UK Equity, then also in the rebounding market of 2009.
Though it hasn’t been a top quartile performer in every year, slipping into the second quartile in 2008, 2009 and 2011, it is the only fund in the sector to outperform the average in each of those years.
Royal London UK Equity Income ranks eighth in the sector year-to-date with returns of 5.43 per cent, which is around 4 percentage points greater than the FTSE All Share’s returns in 2014’s turbulent market.
While Cholwill holds a few small-caps, he runs a predominately FTSE 350 portfolio and tries to focus on companies that have high dividends and that should be able to increase the amount they pay out over time.
It means the portfolio does look different to some of its peers as while Cholwill owns mega-caps like GlaxoSmithKline and Royal Dutch Shell he also has lesser-held FTSE 250 stocks such as WH Smith and Investec.
This desire to differ from the benchmark is shown by the fact his fund has also been top quartile for its alpha generation relative to its benchmark and its information ratio since Cholwill has been in charge.
The FE Research and Square Mile teams say there are times when the fund could well underperform, such as if sterling were to strengthen or if mid-caps were to fall significantly. However, they both agree that Cholwill is a good choice for investors as he has a proven ability to rotate his portfolio to suit market conditions.
“We hold Cholwill in high regard and believe that his consistently applied investment process, which focuses on cash flow, is wholly sensible given the fund’s investment remit of aiming to grow its dividend distributions over the longer term,” Square Mile said.
“Undoubtedly, performance success has been a contributory factor to the fund gathering a sizeable body of assets, though it is still relatively smaller than a number of competitor products in the equity income sector therefore allowing greater flexibility when trading the portfolio.”
“This was evidenced in 2014 when Cholwill reduced exposure to mid-caps in response to a sharp sell-off in that area of the market and increase the fund's allocation to large caps.”
The fund has a yield of 3.8 per cent and an OCF of 0.66 per cent.
