Investments  

Conceding the fault in our stars

Conceding the fault in our stars

Recent events surrounding the suspension and wind-up of Neil Woodford’s equity income fund will raise many issues

Investors are angry. Regulators are in the firing line.

And some ‘brokers’ have many questions to answer. Over the coming weeks and months (and possibly years) the story will rumble on.

The damage caused is widespread – across the whole financial services value chain. It is not a good day for any of us.

But I want to focus on the nature of star managers more widely.

Key points

  • Performance should be judged over the long term – not based on who is currently considered a ‘star’
  • It could take 11 years to prove a manager had skill
  • The FCA requirement for fund boards to have non-executives is a step in the right direction

In June 2015 the BBC ran a story headlined ‘Neil Woodford: The man who can’t stop making money’.

What should be the rather boring subject of investment management was making headlines. As be seen from the chart, it did not go to plan.

We seek stars for comfort, celebrity, wisdom and because they are special. They are not.

They are human, fallible, driven by ego, sometimes lucky. Good fund management is dull, studious, steady and rather boring.

So what are they, why we fall in and out of love with them and how can we avoid falling for them before it goes wrong?

What is a star?

Should a fund manager who was trying to deliver 2 per cent or 3 per cent a year outperformance really be a considered a star if they deliver 5 per cent?

No, they have failed (luckily on the upside – but it could have equally been on the downside).

Always be aware that if a fund has outperformed by 10 per cent by getting the “bets” right, it could equally have underperformed by 10 per cent if they had been wrong.

Turn the ‘performance’ chart upside down if you want to see the ‘risk’ chart.

 

One assumes most investors are trying to achieve growth in their assets or income, above inflation, over a very long period, from age 65 to 90 for example.

That does not require a fund manager to try to shoot the lights out.

We measure stars over three or five-year time horizons – yet are seeking returns over 10 and 20 years or more.

Consistent and steady would seem to be the watchwords – a long way from being a star and being ‘exciting’.

We need to recalibrate. We need a long-term plan – 20 years or more, instead of worrying about who is going to be a star manager for the next year or three.

We need to be clear about what we need from our portfolio.

Then we can build and monitor the whole portfolio over longer periods to see the results.

The industry needs to help with this recalibration. Assets will be stickier, and outcomes aligned to needs.

How many stars are there?

There are not many. According to Morningstar’s recent European Active Passive Barometer they found “over the 10 years through June 2019, active managers’ success rate was less than 25 per cent in nearly two-thirds of the categories surveyed”.