Active fund managers face a constant battle to prove their higher fees are justified by the prospect of better long-term returns than index trackers, but there is no concrete way of finding a skilled manager rather than a lucky one.
Taking the IA UK All Companies as an example, the average fund in this peer group has actually underperformed the FTSE All Share over the past 20 years with a total return of 318.66 per cent. The index has made 332.29 per cent over this time.
Performance of indices over 20yrs
Source: FE Analytics
However, a look within this shows there is a vast spread of returns from individual funds.
While 39 of the 76 funds with a long enough track record have failed to beat the FTSE All Share, those topping the performance tables have added significant value: Fidelity Special Situations is up 1,113.53 per cent, GAM UK Diversified 899.73 per cent and Invesco Perpetual Income 843.08 per cent.
Shauna Bevan, collectives investment manager at Charles Stanley and a member of FE’s AFI panel of leading fund experts, agrees that spotting a genuinely talented fund manager is a difficult task but believes there are some qualities which can help some to stand out from their peers.
“Separating manager skill from luck is at the very heart of what we do and is by no means straightforward. Fund management, like most businesses, is as much about people as it is about processes and the ubiquity of the term ‘star fund manager’ implies that to be a great fund manager one must stand out from the crowd,” she said.
“However a star cannot just be created, X Factor-style, and the moniker is typically only conferred once a track record of generating superior returns has been established. Consistently achieving above average investment performance is one differentiator but as we all know past performance is no guarantee of future returns.”
So more than just track record has be examined when look for a skilled manager. Bevan says there are some definite character traits that the very best managers tend to display.
“The managers we invest in are driven by intellectual curiosity and a passion for what they do. Many are in the enviable positon of being paid to do something they would choose to do anyway,” she explained.
“They combine self-belief and a confidence in their investment process (manifested by taking a longer term view or by being contrarian) with an ability to be self-critical and to learn from their mistakes. They never forget they are managing money on behalf of their clients and do not to confuse investment risk with career risk.”
While there are many managers who have these qualities, Bevan highlights a handful that stand out. Two of these hail from the UK equity income space, which is one of the most popular areas for investors.
She said: “Examples include Mark Barnett, manager of Invesco Perpetual UK Strategic Income and successor to Neil Woodford who had the courage of his convictions to invest in Thomas Cook correctly identifying it as a potential turnaround story and Clive Beagles and James Lowen, managers of JOHCM UK Equity Income, who adapted the rigorous income oriented process that they had honed at Newton.”
Performance of fund vs sectors and index over manager tenure
Source: FE Analytics
Barnett has built up a strong track record of consistently outperforming both his peers and the FTSE All Share. As the graph above shows, it has total return of 139.89 per cent since taking over Invesco Perpetual UK Strategic Income at the start of 2006.
The fund has also beaten the average return of both the IA UK All Companies and IA UK Equity Income and the FTSE All Share in seven of the nine full calendar years the manager has been in charge of the portfolio.
Invesco Perpetual UK Strategic Income is also highlight rated by the FE Research team, which has put it on the Select 100 list and said: “Barnett has done an excellent job of combining income with capital growth on his fund during some turbulent market conditions and has made bold calls which have made his investors a lot of money in the past.”
JOHCM UK Equity Income has also consistently outperformed under its managers, beating both the sector and All Share in five of the seven full calendar years since Lowen joined the fund. The managers have achieved this by following a process that only allows them to buy stocks whose distributed income is higher than the market average.
Since September 2007, when Lowen was appointed to the fund before being joined by Beagles in April 2004, the portfolio has made almost twice the gains of the IA UK Equity Income sector and the FSTE All Share with a 98.06 per cent total return.
Performance of fund vs sector and index over manager tenure
Source: FE Analytics
It is also an FE Select 100 member and our analysts said: “The fund’s rigid discipline and limits on when it can buy and sell stocks ensures it sticks to its strategy and the fund managers don’t make the common mistake of getting too emotionally involved in their holdings.”
“Keeping to the strategy also means the fund is likely to behave in a similar fashion in future and its holders can set reasonable performance expectations.”
Bevan adds that the investment trust space can be a good hunting ground for skilled managers. Indeed, the structure of investment trusts can be a benefit to active managers, as features such as gearing and a closed pool of asset mean they can implement long-term views more effectively.
“Other investors such as Baillie Gifford’s James Anderson, manager of Scottish Mortgage Investment Trust, have embraced the closed-ended format providing him with a permanent pool of capital to take a long term view of the prospects of companies such as Amazon, Tencent Holdings, Tesla Motors and Facebook.”
Anderson has headed Scottish Mortgage since April 2000 and over this time has generated a total return of 399.04 per cent. This compares with an average gain of 189 per cent in the IT Global sector and a 135.41 per cent rise in the FTSE All World index.
Performance of trust vs sector and index over manager tenure
Source: FE Analytics
The manager runs a concentrated portfolio that focuses on high growth names. It also concentrates on long-term themes such as disruption technologies and the economic rise of China, as well as looking at early-stage investments like the ones he took in Amazon and Alibaba.
Bevan also cautions investors against taking the view that a fund manager with the above traits will always generate positive returns, pointing out that some of the qualities mean they may be out of favour at times.
“Not every fund manager, however great, is right 100 per cent of the time. Indeed given that we cite a willingness to go against the herd as one of our attributes then it is self-evident that performance may deviate significantly from the benchmark or peer group,” she said.
“Being prepared to communicate why performance is weak (even if the contention is that this is temporary) and a clear demonstration that the thesis is continuously being tested rather than dogmatically adhered to is also important to us.”