The first stumbling block is the sheer volume of funds available, as shown by the fact that there are more than 3,000 of them in the IMA universe.
Usually the manager’s track record is the key to any decision, as the majority of investors will flock to funds that have delivered consistent outperformance relative to their peers and the market as a whole.
Marcus Brookes, however, says investors need to take a more sophisticated approach.
Brookes (pictured below) co-manages the successful Cazenove Multi Manager range and uses a strict set of rules within his funds. These have worked so far, as demonstrated by the performance of his five crown-rated Cazenove Multi Manager Diversity fund versus its sector since launch.
Performance of fund vs sector since launch
Source: FE Analytics
He says one major problem is that investors decide on their fund because of its track record instead of holding back and thinking about which funds match the way in which they view the world.
Brookes tells FE Trustnet about his experience with Philip Wolstencroft’s Artemis European Growth fund in order to show why using asset allocation is so important when constructing a portfolio. Why he first bought it
Brookes bought the fund back in 2001, saying it fitted his investment criteria perfectly.
While it didn’t have a three-year track record as a unitised fund, Wolstencroft had run a similar strategy as a broker that had performed well. The fund was also highly rated by analysts, who liked the manager, his process and the fact he was investing in good companies.
Brookes says that it was a difficult time for equity investment, given the fact that the world was just recovering from the TMT bubble, the atrocities of September 11th and the subsequent invasion of Iraq.
However, the manager wanted exposure to Europe and was, and still is, a big fan of Wolstencroft’s “Smart GARP” (growth at a reasonable price) approach, which led him to smaller- and medium-sized companies.
“There is a cheerleader for every bull market, but most leave other far more plausible companies that are cheap,” Brookes said.
“Because of his Smart GARP strategy, he was finding those sorts of companies. These were proper businesses which regularly saw earnings upgrades.”
Brookes’ decision paid off. According to FE Analytics, between March 2001 and December 2007 (when he eventually sold it) Artemis European Growth was the best performing fund in the IMA Europe ex UK sector, with returns of 152.83 per cent, beating its FTSE World Europe ex UK benchmark by more than 100 percentage points.
Performance of fund vs sector and index between Mar 2001 and Dec 2007
Source: FE Analytics
Despite its fantastic returns, Brookes wanted to get out of the fund.
Why he sold it
While Brookes was pleased with the fund’s performance, he says that by late 2007, he began to feel that the strategy Wolstencroft was employing could mean that his capital was at risk.
“The team came to the conclusion that we were coming to the end of a bullish credit environment and almost amazing economic growth” Brookes said.
“While everyone was talking about growth in China and the BRICS, western economies had been growing pretty rapidly.”
“There was the argument that interest rates had been too low for too long, which had allowed financial assets to boom.”
“In general, there were advances in quantitative techniques which meant that people felt they could manage risk.”
“That’s when the alarm bells started to ring. There was this over-confidence in the market, yet at the same time deterioration in the economy which people were willing to ignore. A bit like today in certain respects,” he added.
Given these concerns, Brookes and McDonald wanted to start taking risk out of their portfolios.
One of the casualties was Artemis European Growth. By this stage, Wolstencroft had 22 financial stocks in his portfolio, making up 40.1 per cent of the fund, roughly equaling an 8 per cent overweight compared with the index.
Among those names were banks such as National Bank of Greece, Banco Santander, Allied Irish Banks, Bank of Cyprus and Unicredito Italiano.
“The fund was massively overweight financials and we wanted to be in more defensive sectors like pharmaceuticals as we took the view that if you are sick, you are still going to pay for medication even if there is a recession.”
“Therefore, if our thoughts on the market were correct, Artemis European Growth was totally inappropriate for our funds,” Brookes added.
Our data shows that between March 2007 and June 2012, Artemis was the worst performing fund in its sector, losing a staggering 42 per cent, while its benchmark lost half that amount.
Performance of fund vs sector and index Mar 2007 to June 2012
Source: FE Analytics
Why he bought it back
Brookes bought back into the fund again in June 2012 as the situation in Europe began to improve. The manager became more bullish on Europe, which made the fund’s sector allocation more appropriate.
He was also more bullish on equities in general and began buying funds such as Fidelity Special Situations instead of the more defensive funds he had been favouring.
The manager wanted more risk in his portfolio and thought that the Smart GARP approach would be an appropriate way to generate returns.
From June to the present day, the Artemis European Growth fund has made 71.17 per cent, roughly 15 per cent more than the sector and benchmark.
Performance of fund vs sector and index since June 2012
Source: FE Analytics
Brookes still holds the fund.
Conclusion
Brookes is quick to point out that while Artemis European Growth was one of his most successful investments, things could have gone a lot worse.
“If that credit cycle had continued, then our views would have been completely wrong and the Artemis fund would have, in all likelihood, continued to outperform,” Brookes said.
However, what can investors take away from this?
The first point Brookes makes is that simply looking back at whether the fund had performed well in the three years prior to December 2007 would have offered him no protection against the chaos that was about to unfold a year later.
He says that managers who use certain strategies will either outperform or underperform in certain environments, adding that it doesn’t necessarily mean they are good or bad funds, just as long as the returns are due to a process and not guesswork.
As a result, Brookes encourages investors and advisers to start with a top-down allocation before choosing funds for a portfolio, something he and McDonald do across their fund range.
He also says that investors should have no qualms about selling a fund if they think it is going to underperform, even if they like the manager’s approach.
Brookes by no means thinks it is easy to form a coherent top-down view as an individual and, as a result, he uses a vast number of internal and external resources for help.
However, he says it shows that starting from an asset allocation point of view, rather than just picking funds that have performed well, have a good manager or an easy to understand strategy, will make investors more successful in the long run.
