Thirty years ago, the notion of robots replacing humans was the vision of dystopian science fiction. However, huge technological advances since then mean that ‘intelligent’ systems now pose a threat to many occupations – including fund managers, as automated tracker funds become ‘smarter’ and cheaper.
Passive investing has become very fashionable among both self-directed investors and financial advisers. A decade ago, prior to the financial crisis, passive funds accounted for just over 6 per cent of retail investors’ money. Today, that figure has more than doubled to 13.7 per cent, Investment Association (IA) figures show. In the US, passive funds enjoy a considerably bigger slice of the pie: around 30 per cent of assets under management.
Lower costs are a key attraction – some tracker funds charge less than 0.1 per cent, compared with around 0.9 per cent typically for an active fund. Simplicity is another: an index fund sets out to deliver index-like returns, and that – minus fees – is what investors receive.
A third big driver is growing scepticism about the merits of active fund management, where beating the benchmark is impossible to guarantee. Even the most skilful fund managers may fail to deliver index-beating returns. After all, they are human and prone to making mistakes – even Neil Woodford.
Over the summer months Woodford suffered one stock disaster after another, as shares in Provident Financial, AstraZeneca, Allied Mines and AA all fell sharply for various reasons. Some falls followed profits warnings and could have been anticipated, but others – such as the fall in the AA’s share price triggered by the firm’s executive chairman being sacked for gross misconduct – could not have been foreseen.
Rather than hide, Woodford confronted his critics and issued an apology for his fund’s poor performance. Reassuring investors, he said: ‘[While] the short-term performance is painful and difficult, it isn’t a permanent loss of capital. And I can, and I believe I will, rebuild the performance and rebuild that capital that we’ve lost recently.’
Fund analysts have overwhelmingly backed Woodford, insisting that he has not become a bad fund manager overnight. Tom Becket, chief investment officer at wealth manager Psigma, points out that Woodford has tended to run ‘hot and cold’ over his career, but over the long run he has outperformed the FTSE All-Share index by a considerable margin.
He says: ‘When a fund manager is out of form, an investor’s natural reaction is to sell, but they should really be doing the opposite, as peak negativity around a fund manager can be a sign that they are about to start outperforming again.’ He adds: ‘Investors who want certainty in terms of performance, though, should stick to a simple tracker fund.’
Ben Yearsley, a director at Shore Financial Planning, agrees. He says fund investors need to try to work out why a fund manager has underperformed and decide what to do next. He adds: ‘As a fund investor, you don’t want your funds all doing the same thing. If you do, you may as well just stick all your money in one fund. So as long as you know the reason for the underperformance, you can be comfortable. Clearly if the manager has simply been buying poor companies that keep on failing, you may want to sell, but if it is a value or growth call or a small versus large company reason, I’d be happy to keep holding.’
When a fund manager underperforms, the one thing fund analysts want to see more than anything is the manager ‘sticking to their knitting’. In other words, they don’t want to see fund managers lose faith in their own investment philosophy – changing tack from being a value investor to favouring high-quality growth stocks, for instance.
The fact that Woodford has not been apologetic about his style and strategy is the reason why he has retained the backing of most fund analysts, although Yearsley has bucked the trend by recommending clients sell Woodford Equity Income, amid concerns over Woodford’s unquoted positions. These make up around 10 per cent of the fund, a bigger position than he held at his old employer, Invesco Perpetual.
‘We have recently advised selling out of Woodford Equity Income, and it quite simply came down to the unquoted holdings in the fund. I don’t think they’re entirely appropriate for a mainstream equity income fund,’ says Yearsley.
Other experts, though – including Victoria Hasler, head of research at analyst Square Mile – say nothing has fundamentally changed in terms of Woodford’s approach. ‘When you look at his career track record, periods of underperformance are common. But he then turns it around. I’m not worried,’ Hasler says.
Similarly, Rob Morgan, a pension and investment analyst at Charles Stanley Direct, has offered Woodford his support. He says: ‘If I felt a fund manager’s philosophy had become fundamentally broken or they had lost faith in their own strategy, I wouldn’t hesitate to sell. But in the case of Woodford, I think he has been hit by a perfect storm of one stock disaster after another.’
Value investor victims
Woodford is not the only star fund manager going through a rough patch: Tom Dobell, manager of M&G Recovery, and Alastair Mundy, who oversees Temple Bar and its open-ended sibling Investec UK Special Situations, have been off the pace for some time now. Both managers are value investors, an investment style that has been firmly out of favour over the past decade.
Dobell’s performance has been dire (see table), yet between 2001 and 2010 he outperformed for 10 years on the spin, which won him a legion of followers, some of whom have remained loyal. Morgan says: ‘It is a fund we have kept faith with, but it has been testing my patience, and we are now reviewing. But it is very different from a standard UK equity fund, and Dobell has rigidly stuck to his principles in attempting to identify where the market has misinterpreted or mispriced the risk of companies in challenging situations.’
Temple Bar has produced bigger five-year returns, but it has fallen short of the average UK equity income trust return. Hasler remains a fan, however, arguing that the fund’s performance is more of a buying opportunity than a concern. She says: ‘Value tends to be deeply out of favour and then, out of nowhere, spring back into favour and outperform, before falling out of fashion again. So those who back a value investor such as Mundy need a lot of patience.’
Another notable name who has seen their performance tail off of late is Richard Buxton, manager of Old Mutual UK Alpha. Buxton made his name at Schroders steering the Schroder UK Alpha Plus fund to returns of 250 per cent between June 2002 and the end of May 2013 – more than double the 110 per cent average return of funds in the IA’s UK all companies sector. But since he left Schroders to join Old Mutual in the summer of 2013, his performance has come off the boil: he now trails the UK all companies sector average over three years.
This suggests Buxton may have taken on too much when he became chief executive of Old Mutual Global Investors in 2015. But Morgan believes Buxton’s preference for economically sensitive stocks such as banks may be to blame. He says: ‘Taking on a dual role and additional responsibilities has made him an easy target, but I think the reason behind fund performance tailing off is down to his preference for cyclical businesses, which have struggled over the past couple of years.’
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