Rosemary Banyard: how to spot an unconstrained fund manager

The manger of the CFP SDL Free Spirit fund explains why so many funds don’t invest freely across the market, and how to spot a truly unconstrained manager.

With the rise and rise of index tracker funds and baskets of exchange traded futures, it is now easy and cheap to get broad investment exposure to the UK equity market. A FTSE 100 tracker will give you coverage of roughly 85% of the FTSE All-Share index, yet the IA UK all companies sector still offers a choice of over 250 open-ended general UK equity funds, most of which would call themselves active.

These funds come in various shapes and sizes, with many having the FTSE All-Share index as their benchmark. What value do they offer over and above a tracker fund? Not a lot, I would argue, unless they are truly unconstrained.

The FCA, the financial regulator, has rightly been on the warpath against closet index-huggers that charge the premium fees of active fund management for doing roughly what a computer can do; in March 2018 it ordered certain funds to pay £34 million in compensation to investors for doing this, but without naming and shaming the funds in question!

Market shape slow to change

As we pass the 10th anniversary of the global financial crisis, it is instructive to look back at the shape of the UK stock market. Ten years ago, the top five UK sectors were oil & gas, banks, mining, pharmaceuticals and telecommunications, accounting for 55% of the UK stock market. Today telcos have dropped down the table, to be replaced by tobacco, and there is some welcome reduction in concentration in that the top five sectors now account for 44% of the index; but four of those five sectors are the same as they were 10 years ago. Not that dynamic, is it?

Truly unconstrained investing looks for attractive opportunities in every sector and in any size of company. In the technology sector, for example, there are only two choices in the top 100 businesses – Sage or Micro Focus – but plenty elsewhere. You could invest in a market-leading supplier of software to US hospitals (Craneware) or a global leader in computer-aided design software for production plant (Aveva). Or there is a host of world-leading industrial businesses to invest in, such as Renishaw, Rotork or Avon Rubber – but they operate in more narrowly defined niches, so they aren’t big enough to feature in the top 100.

One of the unspoken reasons why many open-ended funds invest predominantly in large and liquid companies is that they are protecting themselves against unexpected redemptions. Another is that the larger a fund gets, the harder it is to invest further down the size scale. There is a limit to how much of a company you can own, and buying more smaller companies can mean you diversify the number of holdings too much.

However, fund groups don’t like to close funds completely to new inflows of cash (a process known as ‘hard closing’), as this often triggers outflows from financial advisers. Furthermore it is actually very hard to ‘soft-close’ a fund (which involves closing it only to new investors), as the platforms that dominate the market for both individual and adviser business argue that they are existing holders, and they are not interested in differentiating among their underlying investor base between ‘new’ and ‘old’ fund-holders.

Low correlation with top 10

So how can you tell if a fund manager is truly unconstrained in their approach, simply looking for the very best investment ideas wherever they may be found? You could make use of statistical measures such as active share and tracking error, but there are some quick tests which I find helpful.

The first is to look at the manager’s top 10 holdings and see how many of them resemble the top 10 companies in the UK stockmarket (see table). If correlation is high, ask yourself why. The second is to check whether the fund manager has ever been willing to hold more than a token 1 or 2% cash. Unconstrained managers will often hold more cash if they cannot find good investment ideas at the right price.

A top 10 table of UK listed companies


The third test is to read the monthly manager commentary. If there’s a lot of text describing what the fund manager doesn’t own, that probably tells you they are more focused on index composition than on making you money. What the manager owns should be what counts: you, the investor, cannot spend relative returns.

Rosemary Banyard is manager of the CFP SDL Free Spirit fund.

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