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Think before you follow a lone star

When managers move to a new firm they do not necessarily replicate their former success
Think before you follow a lone star

Electronic payments company Wirecard (Ger:WDIX) was able to count on loyal investor support, including that of some prominent fund managers, until its fall from grace last month. These included Alexander Darwall, manager of European Opportunities Trust (JEO), who was a long-standing advocate of Wirecard. 

Mr Darwall is best known for the years he spent at Jupiter, where he made very strong returns with this fund, previously called Jupiter European Opportunities Trust, and the open-ended fund Jupiter European (GB00B5STJW84). But last year he set up his own asset management companyDevon Equity Management, which assumed investment responsibilities for European Opportunities Trust in late 2019 and maintained a significant position in Wirecard, which accounted for 10.2 per cent of its assets at the end of May. It wasn’t until 18 June, when Wirecard admitted that its auditors could not locate €1.9bn (£1.71bn) of cash, that European Opportunities Trust finally offloaded its shares in Wirecard. The company's implosion has inevitably dealt a blow to the trust's performance.

 

Although heavy exposure to Wirecard was a feature of this trust and Mr Darwall's other portfolios long before he left Jupiter, investors who stuck with the funds he no longer runs have dodged this blow. Mark Heslop and Mark Nichols, who assumed management of Jupiter European, sold down a hefty stake in Wirecard last year.

The Wirecard fiasco also raises the much debated issue of whether you should follow a 'star' manager to a new firm – especially if they will be able to invest via a less constrained approach than they did at the company they left.

Managers go solo for a variety of reasons including a desire to benefit more from the profits their funds generate and for a higher profile. These are not necessarily bad things if it better motivates a manager to focus on executing his or her investment process effectively.

More importantly, managers including Mr Darwall often argue that they want to strike out alone so that they can focus on managing money with fewer distractions. In an interview with fund ratings agency FundCalibre, Mr Darwall recently said he wished to replicate the ingredients for success during his time at Jupiter but with "a little more focus".

However, while managers may want to escape extra responsibilities that can bog them down at a large firm, such as doing interviews and speaking at conferences, the reality of going solo can turn out to be very different.

"Managers might say they're sick of the bureaucracy and go and set up their own business," says Robert Blinkhorn, head of investment management at Wise Investment. "But if they set up on their own they may have to manage a lot of business issues that they previously didn't have to think about. So I don’t buy the argument that they’re completely unshackled and can just dedicate themselves to running money."

Mr Darwall says that he has adequate resources to allow him to focus purely on investing, including the support of former Jupiter colleagues, and Wirecard could well turn out to be just a blip in a long run of strong performance. European Opportunities Trust may well offer a cheap entry point: its shares were trading at a 9.5 per cent discount to net asset value as of 6 July, versus an average discount of 5 per cent over the past 12 months.

 

How solo managers have fared

There are a number of smaller, 'boutique' asset management firms, defined by the Investment Association as those that are independently owned, with a degree of investment specialisation and assets of less than £5.5bn. But managers who have gone it alone and set up such small firms have something of a mixed track record. 

 

Nick Train and Terry Smith, who set up on their own long ago, have both enjoyed great results. But Graham Bentley, managing director of investment consultancy Gbi2, argues that Mr Smith was always a "maverick" who "put a corporate wrapper around his normal behaviour" rather than a regular fund manager. And – importantly – Mr Smith and Mr Train's investment approach, which involves buying and holding a limited number of stocks, arguably requires fewer resources. Such an approach would not necessarily suffer because a manager has a smaller investment team than that available at a bigger firm.

Some lower-profile solo efforts could arguably be viewed as a success. Crux European Special Situations (GB00BTJRQ064), the largest fund run by Crux Asset Management, which Richard Pease founded, has struggled in terms of recent relative performance but held up better over the past few years. Ardevora Asset Management set up by former Liontrust managers Jeremy Lang and William Pattisson in 2010, continues to successfully apply a process based on monitoring company managers, financial analysts and investors for signs of bias. Ardevora Global Equity (IE00B3QBT006), a long/short fund, has performed well and offers something different to a conventional global equity fund.

But many managers who set up their own businesses do not enjoy anything like this success. The most sensational example of this is the spectacular failure of Woodford Investment Management last year. A combination of ill-fated stock picks and a focus on illiquid holdings proved to be the undoing of Neil Woodford's business, and much of this arguably relates to an absence of the infrastructure and constraints seen at larger asset managers. The Woodford collapse was preceded by many warning signs about what can go wrong with solo ventures, including a manager going beyond their traditional remit, focusing heavily on non-investment activities such as fund promotion and engaging in unorthodox practices such as switching holdings between funds.

Other small asset management firms have gone to the wall without such obvious red flags. Sanditon, which was co-founded by former Schroders manager Julie Dean, struggled in terms of fund performance and shut up shop in 2019 after its investment process failed to come good. Commercial pressures had a major impact here: as Sanditon's value investment style struggled, many of its funds failed to build up the scale required for a boutique business to flourish. Larger firms are better placed to endure such pressures for longer.

With others the jury is still out. Rob Burnett, a European value manager who made his name at Neptune Investment Management, has set up Lightman Investment Management and last year launched Lightman European (GB00BGPFJN79). This fund has already amassed some £200m in assets, but Mr Burnett's contrarian style is yet to pay off. It has fallen around 12 per cent over the year to 6 July in sterling terms, with its top holdings at the end of May including troubled asset manager GAM (GAM:SWX).

Because many solo ventures succeed or fail quietly it is difficult to judge the broader track record. However, managers who set up their own firms can do well if they are properly resourced and can stick to the process that made them successful in the first place. Devon Equity Management has apologised for sticking with Wirecard, adding that the European Opportunities Trust portfolio "continues to be subject to the same risk and concentration limits determined by its board which, for example, preclude any positions from being added to once a holding amounts to 10 per cent of net assets. These are hard coded into our order management system."

A focus on risk management and liquidity has also meant that the trust has not been able to use derivatives since Devon assumed management of it, even though it had in the past. And it cannot invest in unquoted stocks. But other key elements of the investment strategy, including the ability to take large position sizes, remain in place.

 

What to look for

Deciding whether or not to follow a manager to a new firm requires a level of due diligence that not everyone has time for. "You need to analyse the business [which they are moving to] – not just, for example, whether UK or European equities look attractive," explains Mr Blinkhorn.

Consider whether the new firm has adequate financing and assets under management, and whether the fund manager has similar resources to those previously available. This could include analysts who contribute significantly to the investment process, and managerial and administrative staff so that the manager doesn't need to focus on non-investment functions. It can pay off to check if a manager is focused on investing rather than other activities that could prove distracting.

"When Neil Woodford was at Invesco he never went out on the road and the argument was that he was too busy running money," says Mr Bentley. "But at his new business he was always on the road. He was almost drawing attention to the fact that he had less time to run money."

He adds: "Are they in the press more talking about the industry? Has their profile been raised in areas not associated with them? Are they talking about markets they haven’t talked about before?"

Managers moving beyond their main remit can be a red flag, such as Neil Woodford's increasing allocation to unquoted stocks. Managers should focus on their areas of strength rather than new regions or asset classes, and outsource responsibilities to others if a business expands.

 

Wait and see

If a manager you rate goes solo, a wait-and-see approach, even lasting a few years, could be wise. You can take this time to check whether they have adequate resources and are focused on investing, and see what their performance record is like at their new company. A value manager such as Mr Burnett, for example, would be expected to deliver strong returns if this investment style is successful again, but to lag behind if the growth style remains dominant.

If backing solo managers is too much of a risk, one alternative is to consider asset managers known for their skill in hiring good managers and giving them enough resources to focus on investment while interfering as little as possible. Companies with a reputation for doing so include Liontrust, Artemis, Polar Capital and Marlborough.

As always, multiple factors can decide whether an active manager's performance comes good or not. But ensuring a manager has a good combination of independence and ample resources can help you avoid a number of pitfalls.