Investors wanting to buy the best funds have to put their money with managers with the strongest process, avoid those who completely ignore the benchmark and keep a firm eye on risk-adjusted performance, according to Standard Life Investments’ Bambos Hambi.
Hambi, who heads up the asset management house’s MyFolio range of fund of funds, has five rules for fund selection that he has developed over his 37 years in the business. Every holding in his portfolio has to meet these criteria and any that start to lag on them become a candidate for sale.
The below graph shows how a rigorous approach to fund selection has paid off in his Standard Life Investments MyFolio Multi Manager III, his largest unfettered growth portfolio, since its launch in September 2010. It has made a 35.20 per cent total return, compared with a 29.69 per cent gain by its average peer in the appropriate FE risk-targeted sector.
Performance of fund vs sector since launch
Source: FE Analytics
Our data also shows that the fund is top quartile when it comes to risk-adjusted returns as measured by the Sharpe, Sortino and Treynor ratios, maximum drawdown and alpha generation, although its annualised volatility has be higher than its average peer since launch.
In order to achieve these results, Hambi and his team will only invest in the funds in which they have the highest conviction and use the following rules to establish that.
Philosophy – knowing what a fund is trying to do
Hambi said: “The starting point for us is always philosophy: trying to understand what it’s aiming to achieve. Is it trying to shoot the lights out or is looking to protect capital?”
He adds that an important element of this is trying to understand how a manager approaches the market. While he avoids funds that hug the index, he says managers need to be aware of the benchmark – choosing to ignore it is a big worry.
“You need to have to some way of measuring a manager’s performance. I like them to be aware of the benchmark but be able to say ‘the oil sector is 10 per cent of the market but I don’t like it’. If they get that right they’re a hero, they get it wrong there’s egg on their face,” he said.
“There are some processes that will not let a manager buy certain parts of the market – so there’s a few funds out there that I won’t touch because they’re ignoring 50 per cent of the stock market. Some say ‘I can’t understand banks, I can’t understand insurance companies, I’ll never invest in miners and I’ll never invest in oil companies’. Well, they’ve just taken out a huge chunk of the market and I’ll never go there. I want a portfolio that will perform year in, year out and if you’re benchmark-aware you have more potential to be consistent.”
Process – knowing how a fund invests
Hambi (pictured) focuses a lot of his attention on a fund’s process – or the system that the manager uses to implement their investment philosophy.
“We spend most of our time on process and what we’re looking for is evidence that a process is repeatable,” he said. “We’re looking for consistency, we’re looking for skill over luck. I’ve come across some managers whose process is weak and because of that we won’t touch them.”
Understanding how a fund will put its money to work is often seeing as a key to buying the right portfolio at the right time. Knowing that a fund tends to focus on defensive companies, for example, means that it could be appropriate for investors who prioritise downside protection, while those that prefer cyclicals might be better suited to those confident on the economic outlook.
People – knowing who is running the money
“Always meet the managers; never invest unless you know the people,” Hambi said.
“Ask if there’s a key individual behind it? Quite often there is. We like teams but we will back an individual. We like to sit in on analysts meetings, my guys have done that with the likes of Schroders, Fidelity and Newton. We do a lot of work in background on the people behind funds.”
Admittedly, this is a harder rule for everyone to follow – there are very few managers that have the time to meet all potential investors in their fund. Any that did probably wouldn’t have much time left over to run their portfolio.
However, the increasingly transparent nature of the asset management industry means that managers’ outlooks and views on the market are easier to come by than ever. This means that the investor who has the time to do enough research on their funds can come up with a pretty good idea of what a manager is thinking and where they might be taking their portfolio.
Performance – knowing how a fund has already done
“At this level we want to know things like if it’s supposed to be a riskier fund, has it given the appropriate risk-adjusted returns? Looking at the quant here also gives evidence on whether the philosophy is what we believed it was, rather than what the manager told us he believed it was,” Hambi said.
Looking at returns might not offer an indication of how a fund will do in the future, but it allows investors to see if it has performed in the way it was expected to. This check means they can be sure that each holding is filling the role it was bought to do.
“There was one manager who told me they like to buy cheap stocks but when we ran their underlying stocks through our analyser it told me they didn’t have a value bias. It turned out their definition of value was very different to what you might expect.”
Price – knowing what you’re paying for a fund
After all the above factors have been considered, Hambi says the final decision can rest on how much a fund is charging for its services. This means paying close attention to its ongoing charges figure, as cost is significant determinant of long-term returns.
Hambi said: “Normally, there are half a dozen from each area that pass all these tests and we’d happily buy for the next 18 years. Then it comes down to the best price.”
