Some fund managers are too short-termist and not focused enough on long-term returns, according to Scottish Mortgage’s James Anderson. 
The fund manager said therefore that it is important to research the universe rather than blindly banging the drum for active management.
“I am more dubious than most people about trying in some way to defend or promote active management, per se,” he said. “There are many active managers who I don’t think deserve to succeed and don’t do a good job for their clients.”
The three key elements to these funds are higher fees, a closeness to the benchmark index and a focus on the short-term performance.
All of this means that such funds “in many cases they do an awful lot to undermine good corporate governance,” Anderson (pictured) said.
“I would rather see people invest in an intelligently-run, low-cost passive funds than obsess about those sorts of active managers’ fates and fortunes,” he added.
The manager said it is much more important to outperform over the long-term than the short as it is impossible to win year-in and year-out.
Indeed, while the Scottish Mortgage Investment Trust has been among the top performers in the IT Global sector over the last decade, it still underperformed the FTSE All World benchmark in 2008, 2011 and 2016.
Performance of fund vs index over 10 calendar years
Source: FE Analytics
“As far as we can work out we have made 4 per cent [per year] above the FTSE All World index over the entire 110 years,” the manager said, although he noted that some of this data from the trust’s earlier period may be a little less trustworthy than the more recent data.
“If you break it down in somewhere between a third and a half of those individual 110 years we have underperformed,” Anderson added.
“I think that one of the greatest dangers is this game of trying to prove you can outperform every year. Yes, I think you can outperform personally, but we certainly cannot outperform consistently if you define it year-on-year.
“To try and do so is one of the most inherent dangers of fund management that we have been forced into by a whole set of underlying circumstances.”
While it is almost impossible to outperform every year he said, there are measures that can be monitored to give fund managers a better chance of outperforming more consistently, such as active share.
The measure compares a fund’s underlying portfolio relative to the benchmark and gives it an appropriate percentage weighting. Those with a low active share are paying close attention to the benchmark while high active share funds are taking larger bets away from an index.
Anderson said: “There were 15 years when we abandoned the principles, where our active share collapsed and it is no coincidence that over that time we did not produce that 4 per cent per annum outperformance.”
Overall, the Scottish Mortgage Investment Trust manager said there were three key things that fund managers need to have in order to outperform, with the first being a supportive firm.
“You have to have exist in a firm that values the task and the skill and not one who is trying to make money or provide security and bonuses for its employees,” he said.
“I think one of the most understudied features for the problems with the global economy is how far those problems have been created by fund managers who are merely interested in risk aversion rather than trying to build great businesses. It seems to me that it is profoundly important.”
Second is the need to have good, long-term clients who are willing to back funds and managers during periods of weak performance.
This means that investors need to forgive some mistakes and should not focus on the short-term swings in underlying companies.
“I find it amazing that in over 30 years of doing this job I have never had a first question from a client that is about a company that has done well – it is always about companies that do badly,” Anderson said.
“That’s not very helpful but that is nothing compared to clients that pick away at quarterly performance numbers and the like.”
One company that he said has been of particular interest to short-term investors in the investment trust is Tesla – the fifth-largest holding in his five FE Crown-rated investment trust.
Over the last five years the company has risen by 210.12 per cent, as the below chart shows, but concerns over its leverage and cash burn rate mean some are concerned.
Performance of stock over 5yrs
Source: Google Finance
“Frankly, when 20 questions come out every day about Tesla or there is an endless critique from clients or whatever, I really could not care less about that or having to observe some quarters of underperformance,” Anderson said.
The final importance is for fund managers themselves to not overextend themselves and attempt to outperform all the time.
“I am not sure that the best way to outperform is not to try to do so and to try to think about what the broader purposes may be,” he said.
Indeed, he noted that if investors back long-term quality businesses that are making real change in the world then this will be reflected to investors in time too.
“When I say fund management has done a very bad job for our societies and our economies it is because we have forgotten what we are really doing,” he said, which is to provide capital where it is needed most.
“No wonder our productivity is lousy if all we do is encourage companies to pay out cashflow and dividends. That’s not going to get us anywhere.
“If we can concentrate on building better companies then the outlook for our clients becomes better longer-term.”
Anderson has run the £7.1bn Scottish Mortgage Investment Trust since 2000, with co-manager Tom Slater joining him in 2009.
Over the last 15 years the trust has outperformed the IT Global sector and FTSE All World index by an impressive 701.53 and 786.63 percentage points respectively, returning 1145.93 per cent.
Performance of fund vs sector and benchmark over 15yrs
Source: FE Analytics
The global equities investment company is growth-orientated with a focus on technology. US giants Amazon and Tesla as well as Chinese internet firms Tencent and Alibaba make up four of its top five holdings.
The trust is among the lower fee options in the sector with ongoing charges of 0.44 per cent, according to the Association of Investment Companies (AIC).
Scottish Mortgage is 6 per cent geared and its shares are trading at a 4.3 per cent premium to net asset value (NAV).