Identifying a great fund, to create the right blend
As the saying goes ‘beauty is in the eye of the beholder’. Whilst the beauty of fund managers plays absolutely no part in our qualitative due diligence, we are constantly striving for greater objectivity in our perception of greatness in our selected fund managers.
Too much choice?
Within the many asset classes that we analyse there are nearly 3000 funds with assets greater than £100m. While some funds grow to seemingly incomprehensible size, there are plenty of other, smaller funds, run by fantastic fund managers. So someone, somewhere is investing in each of these funds, large and small, and you would assume all these investors believe their manager is a good, if not a great fund manager.
Creating a blend
Greatness clearly means different things to different investors otherwise we would all invest in a handful of funds. There are endless financial ratios to judge a fund manager’s ability and each ratio focuses on something slightly different. Parmenion follows a strict quantitative process to establish a manageable universe of what we perceive to be the higher quality fund managers. Then our qualitative process identifies a combination of managers within each asset class to provide clients with a superior blend of different, but complementary, exposures.
Is class permanent?
A great fund for us is not likely to be the one sat at the top of performance statistics over the past 6 months. While past performance is important, we evidence our belief that performance is inextricably linked to risk. How has the manager fared through tough and volatile market conditions, if ever? This often means looking a lot further back than simply the past few quarters. There is more to identifying a great fund manager than simply checking performance. FE Trustnet has recently carried out research based only on total return and looking at how often first quartile managers are able to hold their position over a successive three year period. The conclusion is that today’s winners are more likely to be below average than retain top spot. This is why Parmenion build our own consistency ratio which looks at multiple rolling three year periods’ performance and why we do not focus only on one cumulative time period.
Identifying and buying high-quality managers can often be easier than selling them. If our research has been solid, our hope is to hold funds for long periods, but the time will come to sell a fund. Usually, this comes down to judgement based on the qualitative part of our due diligence process, which is when we interview fund managers to fully understand their investment philosophy and process. Quantitative data provides a key insight into the manager’s risk-adjusted returns however it doesn’t tell us how they delivered those numbers. We have certain defined criteria which automatically prompt a fund review but importantly not a blind sale, they often involve a follow-up meeting with the manager. We will review a fund if a manager is taking on too many mandates or if there is a takeover of their business. Effects of these changes don’t come out in the quantitative analysis unfortunately often until it is too late.
Understanding the reasons for a manager’s underperformance, or their excessive or inadequate volatility is crucial to prevent us from chopping and changing funds unnecessarily. A great fund manager will not outperform through all market conditions and as investors we must be cognisant of this fact. By way of example, in a strong momentum driven market, we would not expect a prudent and pragmatic manager with a keen eye on risk control to outperform.
A continual effort
In summary, there are no hard and fast criteria for selling a fund. The decision is dependent on the specifics of the case, in the context of our performance in the individual asset class as a whole. Ultimately we need to maintain a conviction that an individual manager will outperform on a risk-adjusted basis over the longer term. If that conviction is lost it is important to sell and move on. As we know there are thousands of funds to choose from. Crucially we have to understand why we are holding a particular fund within its asset class and ensure that we have a rounded assessment of that fund against its peers. ‘Great’ doesn’t have to be exciting, in fact, it’s often quite dull. Protecting client capital through harder times is as important as growing it through the good. We are looking to blend exceptional managers who will provide clients with a consistent long-term investment journey. And that means we have to be looking at the detail, in the numbers and in our judgement of process and philosophy, all the time.
Hear Harry speak about fund due diligence at our upcoming investment courses
Our investment team will be travelling the UK once again this Autumn. Here they will share their knowledge and expertise on both core and advanced investment topics. Each event is accredited for 5 hours CPD. The ‘Advanced Principles of Investing’ builds on our hugely popular ‘Fundamentals of Investing’ course, which more than 700 professionals have already attended. These courses are a great way for paraplanners and Advisers to develop investment knowledge and meet the Parmenion investment team.
“The above article is intended to be a topical commentary and should not be construed as financial advice from either the author or Parmenion Capital Partners LLP. If a client wishes to obtain financial advice as to whether an investment is suitable for their needs, they should consult an authorised Financial Adviser. Past performance is not an indicator of future returns.”
Any news and/or views expressed within this document are intended as general information only and should not be viewed as a form of personal recommendation. All investment carries risk and it is important you understand this. If you are in any doubt about whether an investment is suitable for you, please contact your financial adviser.