The Big Theme
When trying to select a good fund, the performance record may seem to be the obvious thing to evaluate. But, as hopefully most investors realise, past performance is no guide to future returns. A good fund does need to beat its benchmark, sector peers and the wider market over the long term, but an important driver of any active fund's return is who manages it, so choosing a good fund manager is a key part of choosing a good fund.
But a fund manager's record may not be the same as the fund they currently run if they have recently taken it over, and there are also times when good fund managers will underperform - no one gets it right 100 per cent of the time. This means it can be more relevant to judge a manager by what they set out to achieve for you going ahead, rather than by the returns they make in any given year.
So choosing the right fund manager means first of all establishing what their investment style is and how they run their funds. There are a number of very different approaches to stock selection and this will have an impact on when they are likely to outperform their peers and sector.
For example, managers who invest in value stocks tend to look for unloved shares that are trading at discounts but which they believe could be in line for a re-rating. By contrast, fund managers who invest in quality or growth stocks tend to use a set of clearly defined criteria to find companies they believe have outstanding qualities. At certain times in the market cycle particular styles of investing will be popular, meaning some managers who don't follow those styles will lag behind. However a good manager should still perform well over the long term.
It can be more relevant to judge a manager by what they set out to achieve for you going ahead, rather than by the returns they make in any given year
For example, Alastair Mundy, who runs funds including Investec UK Special Situations (GB00B1XFJS91), has found himself out of favour in recent years as the majority of investors have preferred growth and quality stocks to his portfolio of beaten-up stocks. But over 10 years to 17 March 2017 Investec UK Special Situations has made 103.3 per cent against 81.2 per cent for the FTSE All-Share and the Investment Association (IA) UK All Companies sector average of 77.2 per cent.
Another important thing to remember is that fund managers do not act alone, and understanding the resources they can draw on within a company is another important consideration when deciding whether you feel comfortable investing with a particular manager.
"It is crucial to understand the amount of support and resources at a fund manager's disposal," says Patrick Connolly, certified financial planner at Chase de Vere. "A manager sitting alone in a shed in Rochdale doesn't inspire as much confidence if they are managing Asian equities as a manager based in Asia with a strong support network of analysts working with them."
There are big differences between fund managers who take top-down views on sectors and countries and then express those via specific stocks, and managers who claim to take a purely bottom-up approach - choosing stocks according to their individual merits.
"Managers have different processes by which they filter the investment universe down," says Simon Dorricott, fund analyst at Morningstar. "Some of them use quantitative screens to narrow down the range of potential investable stocks to a small number. Then there might only be a few stocks that actually need fundamental analysis."
But other managers do not use quant screens so might need more human resources.
Some managers run highly concentrated 'best ideas' funds, which are likely to deviate strongly from their respective benchmarks due to the big bets they take on individual stocks. For example, Franklin UK Managers' Focus Fund (GB00BZ8FPB74) combines the best ideas from the Franklin Templeton UK equity team, with each of the five managers responsible for a different sector. The fund has 42 holdings and has returned 125.3 per cent over 10 years to 17 March, against 81.2 per cent for the FTSE All-Share.
Freedom and experience
Some fund houses adopt a team-based approach, which may mean imposing a similar investment process across all their funds, while other companies allow their fund managers to operate more independently. Newton, Columbia Threadneedle and JPMorgan have more of a team-based approach.
But fund houses such as Jupiter and Artemis give managers greater discretion to make decisions, often resulting in high-profile managers. When Newton Asian Income (GB00B8KPW262) manager Jason Pidcock moved to Jupiter in 2015 he said: "Managers at Jupiter seem to be given a unique freedom and independence to shape their own portfolios, and this is something I will appreciate as I build my strategy."
Mr Connolly adds: "When evaluating a fund manager you need to understand the amount of influence they have on investment decisions: some have a great deal of discretion, while others work much more as part of a team."
And Frank Talbot, head of investment research at Citywire, says: "The fund manager is central to the performance of the fund, after all they are the ones calling the shots and making the important decisions on whether to buy or sell. And on average more than 50 per cent of a fund's performance will have come from when someone else was running it. This disconnect highlights the perils of looking at fund performance in isolation from the management team."
Another important factor is experience. "Nine times out of ten, experience is key," says Darius McDermott, managing director at Chelsea Financial Services. "We rarely invest with a brand new fund manager, although occasionally one stands out and we take the chance. An experienced fund manager can show you how their investment process works throughout the market cycle and articulate what investors should expect from the fund at different times."
Is your manager going off the boil?
While you cannot expect a manager to beat the market 100 per cent of the time, you should look out for some warning signs that could suggest they are not going to do so well on a more permanent basis.
Some managers establish a strong track record when the amount of money they're managing is relatively small, meaning they can be more nimble. But when those funds become larger, their managers may struggle to repeat the previous strong performance.
Mr Dorricott says: "The amount of assets under management (AUM) is important in certain areas, in particular small-caps, as managers can easily be overwhelmed by AUM that climbs significantly and makes it harder for them to exit positions."
You need to be sure that a manager is sticking with the process they have promised to pursue, even when it falls out of favour. That means looking for consistent performance rather than top performance over the short term. Mr Talbot says: "It is a case of knowing what you are buying and understanding when they deliver. If managers start to deviate from your expectations, it could indicate a drift in style. Style drift is often associated with a flimsy investment philosophy and a short-term investment mantra. There are very few managers who have proved they can be a jack of all trades."
Mr McDermott adds: "A good fund manager will be consistent in their process even during periods of underperformance, which they will all have in their careers. Tweaking or maturing a process is good, but deviating a long way from it is bad."
Lack of sell discipline
Buying the right stocks is important, but so is selling at the right time. Recognising the right time to take profits on winning stocks and sell losers is crucial to performance.
The best UK fund managers
Broker TD Direct Investing has compiled a list of the top 25 fund managers running UK equities over the past decade out of a pool of more than 400 funds, and says consistency, experience and long-term returns are what makes a good fund manager. The broker has analysed the IA UK Equity Income, UK Smaller Companies and UK All Companies sectors and put together a list of the managers who have beaten their sectors and benchmark for the past decade net of fees.
The top three are Mark Slater, manager of MFM Slater Growth (GB00B7T0G907), Nick Train, manager of CF Lindsell Train UK Equity (GB00BJFLM263) and Anthony Cross, co-manager of Liontrust Special Situations (GB00B57H4F11).
The rankings show that no one style of investing, type of fund or breed of manager wins out overall. "All fund managers have their own process and philosophy," says the report. "Every manager uses a disciplined approach and sticks to their guns - to the point of being stubborn - irrespective of what markets are doing."
Mr Slater topped the table with an annualised outperformance of 7.17 per cent over the IA UK All Companies sector average between 1 January 2006 and 31 December 2016, and annualised returns of 12.6 per cent. Mr Train outperformed that sector by 6.27 per cent over 10 years, with annualised returns of 11.69 per cent.
Mark Slater and Nick Train lead TD Direct's table of top fund managers
But a look at returns in the 2016 calendar year shows the importance of looking at a fund manager's performance over the long term. The UK's vote to leave the European Union in 2016 had a big impact on fund performance. Just five of the top 25 managers beat the FTSE All-Share over the 2016 calendar year with their current funds.
These include Ben Whitmore, who runs Jupiter UK Special Situations (GB00B66H8P73), and James de Uphaugh and Chris Field, who are part of the team that runs Majedie UK Equity (GB00B8BH0R25). That is partly due to the sharp reversal in the performance of cyclical stocks towards the end of the year. Mining, financials and resources stocks pulled away from consumer staples and steady dividend-paying sectors towards the end of 2016, and value-orientated fund managers outperformed. That left many growth-focused managers who had been outperforming trailing behind.
For example, Schroder Recovery (GB00BDD2F190), a value-focused fund run by Kevin Murphy and Nick Kirrage, who are seventh in TD Direct's list of top 25 managers, lost 12.7 per cent in 2015, while the FTSE All-Share returned 1 per cent. But in 2016 this fund generated a 31.1 per cent total return, almost double the return of the FTSE All-Share.
The managers in TD Direct's list invest according to a wide range of styles in different areas. These include income, where the compounding effect of reinvested dividends boosts returns over the long term, and smaller companies with high growth profiles.
MFM Slater Growth invests in companies with unique business models and good growth prospects. It is a value-focused fund with a concentrated portfolio of 25 to 50 stocks, and since 2009 its manager's unconstrained approach has led to a large weighting in smaller companies.
Michelle McGrade, chief investment officer of TD Direct Investing, says: "There has been much criticism of active funds, with many saying that the average manager has failed to beat the benchmark. But what this means is that people shouldn't invest in an average manager. We analysed more than 400 UK equity funds looking for equity managers with a track record longer than 10 years, so ranking in the top 25 for 10-year performance is a great achievement - these managers really are the best of British."
Managers with distinctive approaches
Successful managers don't take the same route as each other to the top, and some have distinctive approaches. Jason Hollands, managing director at Tilney Group, highlights Anthony Cross and Julian Fosh, managers of Liontrust Special Situations. They are part of Liontrust's Economic Advantage team, which seeks to identify companies with particular characteristics, including strong intellectual properties, strong distribution channels and significant recurring business. See our update on Liontrust Special Situations Fund for more on how Mr Cross and Mr Fosh invest.
Mr Hollands also highlights Jeremy Land at Ardevora Asset Management, who "draws heavily on behavioural finance insights to spot opportunities, risks and anomalies created by biased behaviour in the markets". Mr Laing analyses the way in which market behaviours and the personality types of chief executives could impact on share prices.
Bond fund manager Ian Spreadbury, meanwhile, who runs funds including Fidelity Moneybuilder Income (GB00B3Z9PT62), typically adopts a cautious approach. "This is ideal for those investing in fixed interest and he has established a long and consistent track record," says Mr Connolly. "He is perhaps the ultimate safe pair of hands."
TD Direct Investing defines four of the managers in its list in the following way.
The lone hunter: Mark Slater buys for the long term, seeking companies with growth prospects and unique business models. He believes in running profits and cutting losses.
The scavenger: Alastair Mundy only looks at companies that are deeply unloved and have fallen 50 per cent or more. It takes discipline to maintain this approach, especially during prolonged periods of underperformance, as can happen.
The historian: Nick Trainhasn't sold a stock from his fund since 2013. He spends most days reading and researching. But the numbers prove his approach works.
The power of the crowd: Majedie adopts a different approach to many, with four managers running their own portfolio, then blending them into an overall, diversified fund.
Top 25 UK equities fund managers over 10 years
|Fund manager||Fund name||IA sector||Outperformance of fund sector average in annualised total returns 01.01.06 - 31.12.16 (%)||Annualised return over 10 years to 31 Dec 2016 (%)|
|Mark Slater||MFM Slater Growth||UK All Companies||7.17||12.6|
|Nick Train||CF Lindsell Train UK Equity||UK All Companies||6.27||11.69|
|Anthony Cross||Liontrust Special Situations||UK All Companies||6.01||11.44|
|James de Uphaugh & Chris Field||Majedie UK Equity||UK All Companies||5.24||10.66|
|Paul Marriage||Schroder UK Dynamic Smaller Companies||UK Smaller Companies||3.81||11.42|
|Francis Brooke||Troy Trojan Income||UK Equity Income||3.8||9.06|
|Kevin Murphy & Nick Kirrage||Schroder Recovery||UK All Companies||3.6||9.02|
|Harry Nimmo||Standard Life Investments UK Smaller Companies||UK Smaller Companies||3.24||10.85|
|John Wood||JOHCM UK Opportunities||UK All Companies||3.16||8.59|
|Ben Whitmore||Jupiter UK Special Situations||UK All Companies||3.07||8.49|
|Martin Cholwill||Royal London UK Equity Income||UK Equity Income||2.85||8.11|
|Matt Hudson||Schroder UK Alpha Income||UK Equity Income||2.78||8.04|
|Daniel Nickols||Old Mutual UK Smaller||UK Smaller Companies||2.61||10.22|
|Mark Barnett||Invesco Perpetual UK Strategic Income||UK All Companies||2.6||8.02|
|Neil Woodford||CF Woodford Equity Income||UK Equity Income||2.57||7.99|
|Alastair Mundy||Investec UK Special Situations||UK All Companies||1.74||7.17|
|Richard Buxton||Old Mutual UK Alpha||UK All Companies||1.72||7.14|
|Nigel Thomas||AXA Framlington UK Select Opportunities||UK All Companies||1.63||7.05|
|Audrey Ryan||Kames Ethical Equity||UK All Companies||1.58||7|
|Adrian Frost||Artemis Income||UK Equity Income||1.13||6.39|
|Stephen Bailey||Liontrust Macro Equity Income||UK Equity Income||1.12||6.38|
|Mark Costar||JOHCM UK Growth||UK All Companies||1.06||6.49|
|Andy Brough||Schroder UK Smaller Companies||UK Smaller Companies||0.72||8.33|
|Mike Fox||Royal London Sustainable Leaders||UK All Companies||0.53||5.95|
|Derek Stuart||Artemis UK Special Situations||UK All Companies||0.49||5.92|
Source: TD Direct Investing
|Fund sectors and indices||Annualised performance 01.01.06 - 31.12.16 (%)||*10-year total return 01.01.06 - 31.12.16 (%)|
|IA UK All Companies||5.43||69.84|
|IA UK Smaller Companies||7.61||154.93|
|IA UK Equity Income||5.26||94.16|
|FTSE All Share||5.56||100.57|
|FTSE All Small Cap Ex investment Trust||4.87||108.91|
Source: TD Direct Investing and *FE Trustnet
|How to choose a fund manager
1. Decide on your asset allocation: You may well like the look of a fund, but risk being over exposed to the area it invests in if you already have something else focused on that in your portfolio. So set your geographic and sector exposure before you home in on a personality. "You need to consider any investment funds in the context of your overall portfolio and not look at them in isolation," says Mr Connolly.
2. Determine your risk tolerance: A racy fund might perform well but be too volatile for your needs. Mr Connolly says: "It might not be appropriate for you to invest with some of the best or highly regarded managers if the funds they manage aren't suitable for you. This could be because they run funds that are too risky for you, or in the case of some fixed-interest or absolute-return funds, not risky enough."
3. Don't get swayed by investments just because they are at the top of the performance tables: Strong recent performance could be a warning sign rather than an opportunity to buy if the investment gains have already been made, and you risk jumping in at the top of the market. Look instead for long-term performance.
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