In the world of asset management, fund managers’ experience is often emphasised as an argument in favour of buying their fund. But closer analysis reveals that it is far from guaranteed that those with long track records will perform better than novices.
In a study from 1998, Northeastern University assistant finance professor Gary Porter and Bryant University professor of finance Jack W. Trifts focused on the role that experience plays in managers’ performance. They looked at 93 experienced fund managers in the US who had managed the same fund for at least 10 years. Analysing the fund managers’ trajectories, they found little evidence that performance persisted among these managers. Neither did they find any evidence to show that performance over the first five years of their careers was in any way predictive of performance over the last five.
A more recent study from 2012 produced even less encouraging results. Examining 289 fund managers, the same researchers found an inverse relationship between tenure and performance. That is, they found that as managers become more experienced, their performance actually declines.
Those fund managers who do well in the beginning of their career are likely to stay in the business for longer. But there is no guarantee that they will outperform in later years. As a result, Porter and Trifts suggest that a successful career in fund management has more to do with avoiding underperformance than generating outperformance.
Earlier in 2017, Andrew Clare, professor of finance at Cass Business School, analysed 357 US fund managers with track records of at least 10 years. He found that this group of managers delivered a small outperformance (after fees) above their benchmarks, of around 0.4 per cent per month over 10 years. But once he delved deeper into the data, he discovered ‘a deterioration of excess performance over time and, in addition, little evidence to suggest that performance persists from one year to the next’.
Instead, he found that the ‘ability of these managers to outperform their benchmarks waned’ in the long run. This might be the case, he speculated, because it is possible that as the managers progress in their careers, the incentives to take risk decrease for them, and therefore their opportunities to outperform decline.
However, Clare’s study provides another fascinating insight. Of the set of long-serving managers he studied, the funds of those who did the best tended to have the following characteristics: more concentrated portfolios comprised of fewer holdings; lower fund fees; large fund size relative to the size of the fund management company; and a positive bias towards small stocks and a negative bias towards value stocks. ‘It is always difficult to establish cause and effect,’ cautions Clare. ‘It is quite possible that these might be good characteristics to search for in all managers.’
Experience does matter
But many investment experts still argue that experience matters. Ryan Hughes, head of fund selection at AJ Bell, says: ‘I believe that one of the key tenets of successful fund managers is having a repeatable investment process, and this can only be evidenced using a sensible time period. Managers with long experience give us comfort that they understand how to invest, and importantly they are more likely not to be derailed by certain events, macroeconomic or company-specific.’
He gives the example of Richard Pease at Crux Asset Management, a bottom-up stockpicker of 30 years’ experience, who ‘is the first to say he doesn’t try and call the macro environment’. Likewise, Nick Train of Lindsell Train ‘focuses on businesses that generate cash, which points him towards certain areas of the market’. For Hughes, these managers’ understanding of their own investment process is down to their long-term experience.
He adds: ‘While looking at experienced managers is not a guarantee of success, it helps separate the skilful from the lucky. After all, it is easy to be lucky over a short period, but impossible to be lucky over a longer time frame.’
Echoing this sentiment, Patrick Connolly, certified financial planner at Chase de Vere, believes that the experience of a fund manager should be an important factor in making investment decisions, arguing: ‘You are more likely to have faith in a manager with a consistent track record, even if they underperform in the short term, rather than in a manager with a poor record or a new manager with no visible track record.’ While he concedes that past performance does not guarantee future returns, he argues that it can provide an example of how the fund may perform in different market conditions, which could be a reflection of the underlying investment process.
Another aspect to consider in conjunction with a manager’s experience is how much autonomy he or she has in the investment process. Some managers have a great deal of discretion, while others work much more as part of a team.
Connolly says: ‘Some investment companies, such as Newton, JP Morgan and Threadneedle, adopt a strong team-based approach and so if a manager leaves it often makes little difference to the investment decisions or how the fund is run. Others such as Jupiter and Artemis give individual managers more discretion, which is why the managers at these companies are likely to be better known by investors.’
There are other factors bound to interplay with a manager’s experience, such as the level of resources at their disposal. For example, strong regional and local support may make a more significant difference to a fund’s performance than managerial experience. ‘If a manager of Asian equities is sitting alone in a shed on the Shetland Islands, this doesn’t inspire as much confidence as a manager based in Asia with a strong support network of analysts working with them,’ argues Connolly.
Further, a manager who has spent a long time at one company should know how to best make use of the available resources; conversely, if a manager moves from one company to another, the resources they have at their disposal will change and it may take time to adjust. Connolly argues that those fund managers with the best reputation in the industry have usually spent a considerable amount of time at one company, including Neil Woodford, Nigel Thomas, Richard Woolnough, John Chatfeild-Roberts and Ian Spreadbury.
Connolly adds that some funds establish a strong track record when the amount of money they’re managing is relatively small, meaning the manager can be nimbler. ‘However, small funds that perform well tend to attract more money and so become larger, at which point the manager [regardless of the experience accrued] may struggle to invest in the same way and repeat their previous strong performance,’ he suggests.
Does it matter for investors?
Fund Expert’s Brian Dennehy takes a different view altogether. He maintains that the experience of an individual fund manager is primarily a concern for their employers, rather than for investors. ‘Once they are in the job my primary concern is whether they are performing. I really don’t care if they achieve this because they are skilful or just lucky. It is perfectly possible to explain away extended periods of outstanding performance by Woodford or Buffett as a statistical freak – luck rather than skill.’
He echoes the Black Swanauthor Nicholas Taleb, who famously argued that there is not enough evidence to show that it is Warren Buffett’s skill, rather than his good luck, which is responsible for the billionaire’s astounding investing success.
Therefore, experience on its own may not be telling of whether a fund manager is likely to outperform. Looking at their experience in conjunction with their investment approach, and whether they have a strong team, good resources, and local knowledge, can help to tell the wheat from the chaff. But even then their good performance may be down, in part at least, to good fortune.
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