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Train: The biggest sin in the fund management world is holding too much cash

15 June 2016

The star manager tells FE Trustnet why trying to time to market could ultimately get a fund manager sacked and why every five minutes spent contemplating the investment implications of Brexit is a five minutes wasted.

By Alex Paget,

News Editor, FE Trustnet

The biggest sin a fund manager can commit is trying to be too clever and hold onto cash in a rising market, according to FE Alpha Manager Nick Train, who says they have a duty to invest all of their client’s capital and are putting them at long-term risk if they decide to leave it sitting in their cash account.

Train, certainly over recent times, is renowned for his consistent outperformance relative both to his peers and the UK equity market as a whole.

FE data shows, for example, that both his Finsbury Growth & Income Investment Trust and CF Lindsell Train UK Equity fund have beaten the FTSE All Share in each of the last nine calendar years and are beating the index once again in 2016.

Performance of fund and trust versus index

 

Source: FE Analytics

The strange part of that outperformance, however, is how ‘inactive’ Train has seemed. His strategy revolves around buying high quality companies with reliable earnings and a strong franchise within a concentrated portfolio – then holding them for the long term.

Indeed, he has bought just one stock and not sold any in the last five years.

He says that though it is a simple approach to investing, he finds it amazing how many of his peers adapt (or completely overhaul) their portfolios on the back of macroeconomic head and tailwinds. In particular, he thinks building up cash levels due to macroeconomic uncertainty – such as risks surrounding Brexit, the US presidential election and China’s challenges at the moment – is a huge mistake.

“I start with a pragmatic observation, though many may think it is a cynical observation. The truth is, being bearish about equities is dangerous for your career security. The reason I say that, certainly in our experience, is because the biggest sin in our industry (I’m not talking about illicit sins) is holding too much cash in a rising market,” Train (pictured) said at the recent Investment Trust Advantage conference hosted by investment trust reseach boutique Kepler Partners. 

“Clients find it very, very difficult to deal with finding out that when they have committed capital to what they know is a risky asset class, the market has gone up and they realise they have not participated because their manager have been too cautious and held too much cash.”

Recent market commentary seems to be at odds with Train’s views, though.

Indeed, with the upcoming EU referendum in the UK and all the uncertainty it brings with it alongside a murky dividend outlook and falling earnings growth, many fund managers have allowed their cash weightings to increase in the hope they will be able to capitalise if share prices fall.

According to FE Analytics, some 11 per cent of IA UK All Companies and IA UK Equity Income funds have cash weightings of more than 5 per cent while three have more than 15 per cent not invested.

IA UK funds with highest cash weightings

  

Source: FE Analytics


However, Train says this is a very dangerous game.

“I’ve seen a number of careers run into the sand and I’ve one or two investment careers come to a premature end because the manager in question thought they were smarter than the market, thought they were right to be bearish and held lots of cash only to sit back and watch the market mock them by going up and up.”

There aren’t many hard and fast examples of fund managers losing their jobs purely because they were dogmatically bearish during a bull market.

However, a circumstance that had similar overtones was the late Martin Gray’s final few years as manager of CF Miton Special Situations as the manager felt the need to hold high cash levels (it reached 30 per cent at times) instead of buying into what he deemed to be expensive bond and equity markets.

Though Gray had a stellar long-term track record thanks to the fact he had protected capital well over the years, this positioning – along with his decision to hold his cash in different currencies – meant he severely struggled in his final two years on the fund (a period when equities made 40 per cent or so) before he left the group.

Performance of fund versus sector and index during Gray’s final two years as manager

 

Source: FE Analytics

Train says it is worth adhering to the advice of legendary US investor Ken Fischer, who once said that “being out of stocks is one of the biggest risks a long-term investor can take”.

The FE Alpha Manager added: “We all feel that being in stocks is risky. No. Being out of stocks is what is truly, truly risky.”

“Since 1928, the US stock market has gone up 55 per cent of all individual trading days, it has gone up 65 per cent of all months and it’s gone up 75 per cent of all calendar years. In the UK, since 1900, the stock market has gone up 73 per cent of all individual calendar years.”

“The odds are absolutely on your side if you are a bull on equities. It is dangerous to bet against those odds.”

Of course, many would argue that underperformance in rising markets as long as their capital is protected more effectively is a far better outcome than exposure to significant drawdowns. However, Train urges investors to concentrate on the long-term wealth generation shares in high quality companies can create.

This, according to Train, is why prefers to focus on the bottom-up fundamentals when running his portfolios rather letting any macroeconomic views dictate his decision to making.


“I have been in this business for a long, long time – 35 years. I have very few regrets about that period, but one is that it took me at least 15 or those 35 years to acknowledge and then act on the veracity and force of these piece of advice from the great Peter Lynch of Fidelity fame.

“He said: ‘No one can predict interest rates, the future direction of the economy or the stock market. Dismiss all such forecasts.’”

“It took me a long, long time before I took that advice at face value and began to apply it. I can assure you, as soon as I did so it was, firstly, like a great weight had been lifted off my shoulders and secondly, I promise you, as soon as I did so my investment performance began to improve markedly.”

Performance of Nick Train versus peer group composite since Jan 2000

 

Source: FE Analytics

As such, he completely disagrees with the notion that today’s market with ultra-low interests, slow economic growth, a liquidity- driven extended market cycle and rising political risks is the most difficult to predict as he says markets have always been impossible to predict.

Indeed, he highlight’s Yuvai Harari’s work ‘Sapiens: A brief history of humankind’ to explain his view further.

“What he says is, like history, markets are chaotic in the mathematic sense of chaos theory. That chaos means they are extraordinarily unpredictable, but it gets even worse because like history, markets are one of those phenomena that have the ability to respond to predictions about future events before those future events have actually happened.”

“That means you never know how much has been discounted. So, lets for a moment talk about Brexit. Our view on Brexit is that every five minutes you spend contemplating the investment implications of Brexit is a wasted five minutes.”

He added: “That is because the outcome of the vote is unknown, but even if through some mysterious process you knew the absolute certain outcome to the vote, it still wouldn’t necessarily help you that much because you don’t know how much of that outcome is already discounted."

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