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The three reasons why your global fund fails to outperform

22 May 2015

The global sectors are among the worst hunting grounds for active fund managers and KBI’s David Hogarty tells FE Trustnet why he thinks that is the case.

By Alex Paget,

Senior Reporter, FE Trustnet

It may seem odd, but the IA Global and IA Global Equity Income sectors have some of the highest proportion of underperforming active funds in the open-ended universe.

Despite the fact they have literally the whole world to choose from for ideas, FE data shows that 62 per cent have underperformed against the MSCI AC World index over the last 10 years. It is a similar situation over one, three and five years.

 

Source: FE Analytics

This is more simply borne out in the performance of the sector average relative to the index, as according to FE Analytics the IA Global peer group has underperformed over one, three, five and 10 years.

Performance of sector versus index over 10yrs

 

Source: FE Analytics

Few have tackled the question of why the global sectors have turned out to be such a graveyard for active managers, but David Hogarty – manager of the KBI Dividend Plus Developed Equity fund – says there are three major reasons why that has been the case.

His fund, which sits in the offshore universe, is vastly different to the funds in the IA Global and Global Equity Income sectors as will be explained later in article.

However, while not bullet-proof, this portfolio construction means his £290m fund has returned 192.78 per cent since its launch in July 2004, beating its MSCI World benchmark and the IA Global sector average, which have gained 175.54 per cent and 143.77 per cent respectively over that time.

The fund, which has outperformed in seven of the last 10 calendar years, is also beating the index over five and 10 years.

In this article, Hogarty runs through his three reasons why he thinks so many of his rivals struggle.

 

Too concentrated

Firstly, the manager says global funds tend to be too concentrated.

“A lot of fund managers cut their teeth with regional portfolios and global mandates are a relatively new concept. However, some have tried to repeat those same portfolio construction rules [that they used in regional funds] with a global mandate and it doesn’t work,” Hogarty said.

“When you look at UK funds, for example, the breadth of the economy is large but it isn’t huge. With a global mandate, you have so many different countries, which are in different stages of their cycles, different currencies and other random factors which are impossible to control.”

“Therefore, the idea that you can cover the globe with just 25 to 30 stocks is crazy.”

Instead, Hogarty typically owns around 250 stocks in his portfolio which represents around 10 per cent of his benchmark.


 

He says that while this may put some investors off, he questions why so many active managers sell themselves on the fact they run concentrated funds as he says that only ups their risk profile. His main focus is capital preservation and he says one of the easiest ways of achieving this aim is to be diversified.

“The industry has managed to get it wrong by believing that you have to sacrifice diversification if you want to add alpha. However, if a fund were too lost 50 per cent it needs to make 100 per cent to make it up.”

He added: “The maths are against you if you are a high-risk investor.”

A recent FE Trustnet article highlighted this as we looked at the funds with the highest maximum drawdown – which highlights the most an investor would have lost if they bought and sold at the worst possible times – against those with the lowest drawdowns.

Performance of portfolios versus index over 10yrs

 

Source: FE Analytics

As the data above shows, global funds with the lowest maximum drawdown have not only comfortably outperformed those which have lost the most possible amount of money, they have beaten the MSCI AC World index in the process.

 

Meeting management teams

The next mistake, according to Hogarty, is the belief that meeting company management teams helps managers to outperform.

Many experts swear on the ‘white of their eyes test’ and the idea that by sitting down with those who are running the company, it allows managers to gain a greater understanding of what is actually going on within the businesses.

However, Hogarty says this “relationship building” means managers end up falling in love with the companies they buy and blindly avoid those that they didn’t like.

“Some managers are fixated with this idea of meeting companies and getting to know management teams and it is often touted as a tremendous benefit – but I just don’t think that is the case,” he said.

“You don’t make any money when you buy a stock; you only make it when you sell. However, if you know the management and have a good relationship with them, it makes that sell decision much more difficult.”

“It also means analysts tend to stick by their stock recommendations even if it is performing poorly or hold onto a stock longer than they should after it has performed well.”

 


 

Making sector calls

Hogarty says the final mistake managers make is their decision to be underweight or overweight certain sectors.

“The argument for being underweight or overweight a sector is based on the complete fallacy that it helps you outperform. Stocks within sectors don’t all act the same. Trying to decide which sectors you are overweight or underweight is a waste of time; it’s a red herring,” he said.  

The manager says there have been various examples of this in the past. For instance, while it may have seemed like a good idea to avoid European banks over recent years, well-capitalised Scandinavian banks have performed strongly.

Performance of indices over 5yrs

 

Source: FE Analytics

Other examples include Japanese automotives, such as the difference in performance between Mitsubishi and Toyota, and oil stocks in the US and in Europe.

As a result, Hogarty tends to keep his sector and regional weightings similar to those of his benchmark and then tries to add alpha buy selecting a handful of stocks from each of those industry groups.

He added: “We try to take risk against the benchmark through stock selection within the various industry groups.”

Hogarty says this approach, as being more diversified, means he can protect capital more effectively. This is shown by FE Analytics, as his KBI Dividend Plus Developed Equity fund has had a lower maximum drawdown than the IA Global sector and its benchmark over the last 10 years.

KBI Dividend Plus Developed Equity has a total expense ratio of 0.86 per cent. 
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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.