Anthony Bolton ran the Special Situations Fund for over 25 years and delivered exceptional results for its investors. When Bolton left the fund in January 2008, however, it was split into two, with the ‘Global’ Special Situations portfolio going on to seriously underperform its peer group.
It is worth mentioning, however, that the performance of the ‘Global’ fund improved significantly after the introduction of another manager in March 2012. Investors that followed Bolton to his new venture ended up faring a bit better; the Fidelity China Special Situations Fund has lagged China’s stock market since the fund was launched.
The above story is an excellent example of the dangers associated with ‘star’ managers. Besides the risk that their performance will disappoint, there’s also the danger of them leaving the fund altogether, leaving investors wondering whether or not to leave with them. It is one of the advantages of funds run by a team.
In this case, losing one member may be inconvenient, but it is highly unlikely to alter how the fund is run. Asset management firms such as Aberdeen have successfully used this team approach. Conversely, an investment team may end up missing out on the X factor that a star manager can bring, that extraordinary ability some have with regards to picking stocks and timing the market, whether it is instinctive or as the product of experience.
One important thing you should note, however, is that star managers usually have analyst teams behind them, perhaps even deputies. Still, the ultimate decision comes to the manager alone, which is remarkably different from a true team approach.
How to Pick a Winner
It is critically important to assess the track record or a fund manager or management team. Fortunately, it is now possible on websites such as FE Trustnet that have separate performance profiles for funds as well as fund managers.
Try looking at both the cumulative performance – how well they have done over the past 3, 5, or 10 years, and the discrete performance – how well they have performed in each individual year. That will give you an idea of how their investment style/strategy copes with different market conditions: down, up, or sideways.
You should also consider looking at how they have done relative to their sector, but always keep in mind that, in most sectors, the average performance could end up being worse than that of the market. According to many fund managers, UK valuations remain cheap.
For instance, the average fund in the UK All Companies Sector delivered £2.62 for every £1 over a period of 10 years ending 31st January, 2013. The FTSE All Share Index, on the other hand, generated £2.71 for every £1 over a similar period.
To beat the sector average in such circumstances is actually not that much of an achievement, since you can actually do it yourself if you invest in an ETF or passive fund. Ideally, you want an actively managed fund to be in its sector’s ‘top quartile’. However, keep in mind that past performance isn’t a guarantee of future returns.
The fund manager’s investment style is something that you need to familiarize yourself with. You can clean this from the reports the manager submits to investors or the promotional literature of the fund. Still, it is important to be ready to wade through plenty of jargon. Here’s a quick glossary of the key terms used to describe the management styles of various funds.
It refers to the yardstick against which the fund has opted to measure its performance. It objectively is implicitly to outperform the set benchmark.
A fund’s benchmark is usually an index, sometimes one that’s well-known like the FTSE All Share, but sometimes it is more specialist like the AFI Aggressive Index. Funds will occasionally choose to benchmark their performance against the sector average, which is something you need to be wary of, because it is often easier to beat the sector than the market.
Top-Down Vs. Bottom-Up
The top-down approach involves first deciding the amount of money to allocate to each sector and region and then picking the most likely companies in those sectors. In the bottom-up strategy, however, the manager focuses entirely on picking individual investment trust or investment and usually pays less attention to the ‘big picture’ macroeconomic factors.
Ultimately, managers usually do a bit of both, but some will focus more on one approach than the other.
The term ‘best ideas’ might sound somewhat odd on the face of it: why would a fund manager put anything besides their ‘best ideas’ in a portfolio?
It is intended to suggest that the manager of the fund may deviate rather significantly from the benchmark. For an investor, it could be a warning sign that the fund’s performance could be either very much worse or very much better compared to that of other funds in the sector, and the fund may end up moving out of step with the market.
Diversification and Concentration
A concentrated fund usually has fewer stocks in it; say 30. In contrast, a diversified fund could have 100 or even more. If you are unable to find out how many holdings the fund has, it is possible to get an idea of how concentrated it is by looking at how much of its assets are invested in its top 10 holdings and comparing that to other funds in the same sector.
A concentrated fund may carry more risk, but it also has the potential to outperform. The more diversified a fund is, the higher the possibility that it will just reproduce the results of the market, which means that you may as well invest in a private tracker fund. The exception is with smaller company funds, which may need to invest in more companies for practical reasons.
The term ‘high conviction’ is similar to ‘best ideas’ and it implies that a fund’s manager has massive holdings in particular stocks, sectors, or regions, and holds a ‘high conviction’ that they are likely to perform well.
It isn’t a term you will hear being used by fund managers. Instead, it is a term of abuse usually leveled at them. It simply means that the fund manager is mainly replicating the benchmark, making just a couple of minor changes.
The benefit for the manager is avoiding significant underperformance, which is at times regarded as more important than achieving real outperformance. However, since investors can always buy genuine index trackers without spending too much money, a closet tracker is arguably conning investors out of their money.
It’s an investment style whose definition has become rather blurred over the years, and currently encompasses a wide range of strategies.
It is intended to refer to a fund which invests in companies where a ‘special situation’ has presented a buying opportunity, such as an acquisition or merger, or a change in ownership or management. In reality, it is mostly used as a marketing term trying to piggyback on the success of Bolton’s Special Situations Fund.
A fund is ‘top-quartile’ if it is among the top 25 percent of funds in its sector. It is usually seen and indicative of quality fund management if a fund is top-quartile consistently.
GARP stands for ‘growth at a reasonable price’, which is a mantra for growth investors. It means that the fund’s manager won’t invest in any growth company no matter its valuation, but will instead look for reasonably priced companies that have potential for growth.
The concept has gained further traction since the tech bubble and bust, when companies labeled as ‘growth’ were snapped up eagerly in spite of their ridiculous valuations.
Disclaimer: This content does not necessarily represent the views of IWB.
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