Fund selector: December purging

Both the buy and sell side seemed to be taking part in a competition to decide who has the most original view of what is going to happen in the world in the next 12 months and how to best position portfolios to benefit from it.

From an intellectual point of view, this is actually quite useful. It is very informative to get most of the industry’s point of view at the same point of time and can be very helpful in terms of articulating your own opinion and strategy. It is not nevertheless without dangers.

As one of my esteemed peers once said, “A year is only the time it takes for the earth to orbit around the sun, it has little if any relevance in investment terms”. It is not unusual though to witness a higher than average level of portfolio reshuffling in the late weeks of December.

Running multi-manager funds, it is very easy for me to monitor this effect. We have noticed that the level of turnover witnessed in December is substantially higher than the average turnover occurring during the rest of the year.

In December 2011, the average turnover by the underlying managers in the Skandia Global Dynamic Equity was twice that of any other month in 2011.

It is hard to assess if this is due to the abundance of research being published around that time of the year or the fact that most fund managers’ remuneration is still mainly a function of discrete calendar year performance, but the phenomenon is very noticeable.

Activity ranks from marginal readjustments and culling of long term underperformers to sometimes dramatic shifts in positioning. Spring cleaning seems to occur early in the fund management industry.

This then provokes a question: Should there be any spring cleaning in the fund management industry, why aren’t managers positioned optimally at all times? Why, as I sometimes hear, don’t managers invest every morning starting with a blank sheet of paper?

The answer is simple; a blank sheet of paper is a luxury that an academic or someone managing a paper portfolio may have, not an actual investor.

The belief that anyone running money could actually turn their portfolio over daily in order for their current optimal positioning to be implemented is somewhat naïve, if not unwise.

There is a plethora of other factors to consider, turnover cost, and implementation effect among others. This is the reason why even with fund managers following a quantitative process, daily rebalancing is almost unheard of. Monthly or quarterly rebalancing are the norm.

I am therefore not shocked at the increase in turnover that I witness in my underlying managers. It is important for us to monitor it closely but I see it more as a once in a year opportunity for managers’ endowment effect or divestiture aversion to take a well needed break.