Manager Research

We provide detailed institutional-quality global investment manager research and fund ratings. Based in the UK and South Africa,
all members of our manager research team have over ten years of investment experience.

Improving client outcomes

19 Aug 2019

We have remained quiet on the Woodford affair, mostly because our views are shared directly with clients, rather than publicly. Equally, we wanted to avoid commenting after the fact, when hindsight offers all the answers, yet it was foresight that really mattered to clients. 

But, as we see the Woodford comments increasing and the subsequent pressure on clients and regulators mounting, we do worry that investors in funds, more generally, may extrapolate the issues they faced on this one strategy into all their selections. What follows is hopefully not seen as lacking in empathy for the clients who are or were investors in the Woodford Equity Income Fund. Equally, we are supporters of certain remedies that can improve client outcomes, like moving to monthly dealing on some funds. And for the record, we suspended our fund rating well before dealing in the fund was suspended.

Firstly, let us state the obvious. Neil Woodford has successfully managed UK equities over long periods, taking a long-term view on stock selections that are dissimilar to the benchmark and often a lot less liquid. He has also performed very poorly in the short term. On a sample size of one, these traits have not benefited clients inside the fund. But we would argue that these are broadly the sorts of traits that clients should seek when investing in mutual funds, with the caveat that they invest in many funds rather than just one. To elaborate, we fear a world after the Woodford saga where investors start to reject these traits more broadly and a) have shorter investment horizons; b) prefer active fund managers that hug benchmarks or own popular names; and c) sell the funds that have done poorly in the near term. 

To reiterate, we look at evidence across all funds, rather than an individual fund, when making our observations. Let us set out some principles investors should keep to, despite Woodford.

Principle one: all else being equal, the evidence suggests that investors should have long investment horizons. This is especially the case with equities, where near-term returns can be quite random, but long-term returns fairly reliable. For example, the UK Equity Income sector has a range of returns over one year from consumer price index -35 per cent to CPI +38 per cent. Over 10 years however, the range of outcomes is far narrower: since 1994, over any rolling 10-year period, the minimum annualised return was 1 per cent and the maximum was 11 per cent and the probability of beating inflation by 3 per cent a year (net of fees) was 84 per cent.

Principle two: Active managers that charge typical active fees (60-90 basis points) should rationally look different to the consensus. The benchmark is a good example of the consensus. It is usually a list of companies, derived from historic data, like historic share price growth and shares in issue. And such companies have often done well to get into the index, which indicates that they may be popular investments too. Would you be comfortable if your active manager’s investment strategy was to own those companies that are the largest, whose share prices have increased significantly and are commonly held by their peers? Why not just own cheaper passives? We are backers of passives, but it seems irrational for genuine, active investors to seek comfort in the index, when they are charging high active fees. Indices are also backward-looking, at odds with active managers that seek tomorrow’s winners. And to enhance their odds of uncovering a future gem, because competition for them is so fierce, active managers should be willing to look where the number of buyers and sellers is smaller, in less popular pockets of the market. This is where it is rational to take liquidity risk, which should offer astute fund managers a real edge.

Principle three: We should be adding to investments when they go down, rather than when they increase. In theory, this should apply to our fund choices. We should gain in conviction the more a fund drops in price. We seek discounts when buying cars, houses and televisions, so why not funds? Fund selection is an exercise in probabilities, where sample sizes need to be broad in order to see whether investors can gain from backing active fund managers. A sample size of one or two proves very little, although we fully appreciate that some clients may well have allocated all their spare capital to Mr Woodford. 

But as fund researchers, we need to look across the widest possible opportunity sets to see patterns and empirical evidence that can help guide us prospectively. This data tells us that, rationally, backing many experienced, proven managers who invest differently to the consensus and who are struggling in the near term with performance should be sensible. Our hope is that, once the dust settles on the Woodford issue, investors remain committed to these principles.

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