Basics
Midweek Musings – Dedicated Follower of Fashion?
Midweek Mashup – Money For Nothing
Global stock markets have reacted as expected to talk of inflation and potential central bank actions but I have already written about that a couple of times. Most markets are around 2% off recent peaks and Sterling has returned to strength after a short pull back. Both these factors will impact the bottom line of our portfolios but only in a way that is part of the normal daily volatility of markets. In my opinion, nothing out of the ordinary, especially in May – remember ‘sell in May and go away’?
In the absence of anything else of significance to investors having come my way recently, I am going to dig into the reasons why things like NFTs (non fungible tokens), Doge coin, neglected old sports cars with worn out engines and even someone’s less than box fresh sports shoes are apparently worth improbable amounts of money – for now.
Midweek Musings – Getting Personal
Introduction
People who work as professionals in investment management will be expected to have qualifications that allow them to apply accountancy based ‘rulers’ over prospective investments, understand at least some basic ideas of statistics and probability and even know the meanings of various Greek letters in the context of their work. In my (unscientific) opinion this seems to explain why fund managers with degrees in the arts or humanities are on average less succesful than those who trained as accountants or who better still have advanced science degrees. Past students of economics may claim to be scientists, but in my opinions they are usually far from that!
There is a similarity between predicting the future returns from investments and weather forecasting. A great deal of computing power can be applied to analysing the past and some human expertise can be added to interpret that data, but in reality, the best we can hope for in terms of reliability is an indication of the most likely outcome.
In the case of the weather it is the scale of the systems operating across the globe (the impact of nature, in short) that makes precise longer term predictions impossible. In the case of stock markets, it is another aspect of nature that can be fickle or not well undestood: human behaviour.
In this weeks post, I intend to explore some ways in which I think investors can apply some ‘art’ in selecting fund managers. You might find what I have observed to be obvious common sense, but I know that many people imagine the people who work in investmemt companies are some sort of elite with wondrous skills. In spite of the fact that many are paid very highly, they are often far from that.
I once wrote that an actuary is someone can reliably calculate the probability of a good salary. A fund manager is usually someone who likes testing out personal prejudices with other people’s money!
A fund manager’s career path
If you have researched funds in detail, you will have read many mini CVs of fund managers as published in fund fact sheets and maybe expanded on the fund group’s web site or in Morningstar analyst research. Of course, in real life, not everyone makes progress for simple reasons of merit or seniority!
Most of the people with responsibility for the final purchses of investments, maybe from lists provided by a process within their firm or maybe just anything they like, will have reached that pinnacle of authority after working as an analyst in the same firm or in a bank or stockbroker. A few might have worked in industry (say as a pension fund manager or accountant) or ocassionally come out of the military or agriculture. Once upon a time, there was a good chance they went to a public school, but the globalisation of UK fund managmenent groups has diluted that particular “chumocracy”.
Most will have added a formal investment qualification to a degree at Bachelors. Masters or even Doctorate level. I have noted a number of people who took physics doctorates as successful fund managers. Such extra qualifications will usually have been secured many years before a the person got to be ‘running money’, but such is the nature of education – our GPs may not have taken an exam for 20 or 30 years. There are of course compulsory Continued Professional Devolopment programs (usually lightweight in my experience).
So far I have outlined the sort of moulds from which our fund mangers are formed and in truth they are a reasonably homogeous bunch, but….
The ‘star manager’ or entreprenuerial fund manager
In his book ‘The Magic Mountain’ Noble prize winning author Thomas Mann introduces late on a striking character that he portrays as a ‘personality’. This individual is able to secure the attention and approval of his associates and friends without saying anything useful, structured or intelligent. This is shocking because earlier in the book, two other characters have been developed as highly educated and intelligent debaters with opposing viewpoints – one a humanist, the other a Jesuit. They just disappear into the background, outshone by the high wattage competition.
The author has in this book shone a bright light on a very important aspect of human behaviour.
We have had the opportunity to observe first hand in politics right now how an individual can rise to the highest level of influence simply by the force of an unusual (perhaps abnormal?) personality. I refer to Donald Trump of course, but one can probably say the same about Boris Johnson, Vladimir Putin and in the past the likes of Stalin, Tito and without doubt Hitler. The list in politics will be a long one.
Now what happens in politics is a mirror of most other aspects of human behaviour, albeit maybe a magnifying mirror. Someone who has the personality to push themselves forward, perhaps because they have ideas they want to try out on their fellow humans, maybe because they want great fame,wealth and luxury or simply because their brains works that way (as withh the classic personality disorders).
My research has shown me that the more extreme personality types (the most ‘pushy’, one could say) tend to get to the top in politics, the entertainment business and in business….
….and in investment management.
Because investing other people’s money is a highly regulated process in the developed world, there are systems that bear down on these most self opinionated of individuals so that their superfluity of confidence, which may through luck or skill see them having runs of success, is at least on a leash.
Those who are not happy with the constraints of others whom they regard as lower mortals will wait until they have a good repuation, have earned enough to fund a new business and talked some colleagues into the joys of escaping the bureaucracy and announce their new business – usually with their name on it.
The implications
Some of what I next propose is based on real events, actual examples and some is based on my own thinking about human behaviour.
There is in my mind no doubt that an intelligent mind is likely to bring an individual into conflict with the objectives and day to day operations of a large international business. Businesses are in effect organisms and their operations are designed to protect the whole in as efficient a way as possible. There is usually no room for mavericks. Who would want to be Elon Musk or James Dyson’s line manager?
The most skilled senior managers know how to manage the best and even the most indepenent thinking employees early in their careers but eventually the strong willed individual acquires enough status (the ‘star’ badge) such that they are almost unmanageable. I am not an innocent in all this – my accountant once said to me that he and I were alike in that we were unemployable, meaning we had got to the point in life where we wanted to test our ideas without a hint of supervision. Good fund managers reach that point sometimes.
Some will set up a business with insufficient parallel resources, such as in compliance or sales and marketing and will simply be unprofitable. This is very common and many managers move back into the fold of a fund group that is a little more respectful of them than their past employer and they then run funds in a semi authonomous way, but with appropraite controls. Jupiter, Liontrust. Premier Miton, MAN GLG and others all have managers working for them that have been through that loop and in my judgement that is a positive. They have pulled their horns in a bit but still have individual talent.
Others, and this is where we must take extreme care, in spite of having very few people working with them, see their businesses storm ahead and so they attract billions in funds. You will know some examples: the now disgraced Neil Woodford, the very rich Terry Smith (Fundsmith), Messrs Lindsell and Train, Alexander Darwall (Devon). Others may be less familar – Teviot, Crux and Chelverton, for example. It is perhaps significant that the last 3, although all founded by people ‘setting up on their own’, do not have the founder’s name out up front!
The wrap
In summary, it is no surprise that quite a few top fund managers have strong personalities. This may be what got them to the top, rather than any other special skill. If they find the restraints of corporate life frustrating, they sometimes go off and do their own thing, with or without associates strong enough to rein in their wilder ambitions, whims and personal biases.
Most will fail and return, chastened to the corporate fold. A very small few will succeed and get very rich, which probably means they cease to be actually running money anyway. A separate small number will take a wrong turn or two, refuse to reverse and end up losing an awful lot of other people’s money.
As investors, we need the art of assessing people in general and using that in a common sense way to assess the risks of trusting our money to ‘big personalities’. As a rule of thumb, I don’t trust the breakaway new funds!
Monday mashup – the everlasting active vs. passive debate
A refresher
Readers will likely know that investment funds are usually managed, either to own stocks in a specific country or industrial sector, or to manage a mix of assets (multi-asset). Investors pay fees, often quite high fees, because they think managers will apply skills to improve total returns and control risks.
Some years ago an American called John Bogle suggested that in the US fund managers actually delivered returns below that of their benchmark, say the S&P 500, most of the time. He then launched a business called Vanguard that offered investors a much cheaper way of investing by just buying an investment that more or less replicated the benchmark index.
There is more about this in detail in the article “Investing without management’ which can be found by searching using the key word “Passive”. This post is one for subscribers only.
There are other posts addressing the issue from different angles, including one of the first ones I ever wrote in March 2018, explaining how tracker funds tend to be more volatile
Recent Evidence
The research company Morningstar has reported on the relative performance of the average managed fund versus the average passive (tracker) for some years and recently released their European Active/Passive Barometer which looks at data over the last 10 years across all world markets. It is a 30 page document but one can pull some interesting data from the Executive Summary.
As might be expected, if investing in the main US markets, you might as well pick a low cost tracker because over 10 years only 5.6% of active Large Cap Blend funds survived (ie were available right through the period unchanged) and beat the average passive fund. 30% of small cap equity managed funds did better.
These sample extracts confirm something: fund managers can’t easily add value in markets that are extremely heavily researched and where any one can access all that they need to know about the market components. The more specialised and less researched a market is, the more chance there is for a manager to make money ahead of his benchmark.
It also follows that managers who are not benchmark aware might take very ‘active’ positions (ie go out on a limb) which will add ‘beta’, a separation from the market trend) for better or for worse. A good recent example of that was the Baillie Gifford group owning very large amounts of Tesla stock.
So it is no surprise that on a year to date basis the active funds that come out best are in areas like Korean Equity, Russian Equity, Austrian Equity and various others. One larger market segment where managers seem to do better is the UK mid cap classification.
The UK mid cap sector is interesting because the Brexit overhang means that some stocks in the index will be hugely out of favour and others will look like great value because they are Brexit ‘independent’. It would I suppose be a challenge to create a reliable ‘Brexit beneficiaries’ benchmark (although it may have been done – I have not checked), so well run managed funds have an advantage.
Interestingly, the UK mid cap sector is one where managers have done very well relative to the average passive fund over all period up to 10 years, so this is not just a Brexit related result. Having favoured the Standard Life (now ASI) UK Smaller Companies fund on and off over that period, I am not surprised.
So which to buy – active or passive?
I hope it will be obvious from my comments above and the more detailed articles on this site that I am open minded about these two investment options but would take the view that a passive fund is most likely to serve investors best when it tracks a well known large cap index.
For more focused asset weighting calls, a good manager will probably earn her or his keep.
A final thought is that in investing in funds with mainstream benchmarks, one is in effect taking a decision to go along with the crowd. That is fine and a way of playing the momentum factor, but recent experience suggests that benchmark independent fund managers like Terry Smith at FundSmith and Stephen Yiu at Blue Whale make the most money for their investors.
To balance that, one cannot forget one Mr Neil Woodford’s wandering away from his supposed benchmark and the consequences of that streak of independence!
Monday Mashup – can we be un-biased?
The hyphen is not a grammatical slip -up, although I know there is the odd typo in my output; I like to think it puts me in the same category as The Grauniad.
I am referring to the notion of fighting those human psychological processes generally called ‘biases’. A very good fund manager at Jupiter Asset Management (he has just taken over one of Neil Woodford’s old mandates) once said he spent his working days fighting his human biases so that he would stick to his logical and tested investment training, experience and processes.
Common traits, as they have been called in a less academic way for many years and in many contexts of life, can trip up investors at all levels of experience and expertise. I have a T-shirt with the this quote from Mark Twain on it: ” When you find yourself in the majority, it is time to stop and think”.
The point is not that the majority are always wrong or that being a contrarian is a badge of good judgement, but that it is easier to ‘go along with the crowd’ so one ought to ask why are the crowd thinking that way and do we agree with it if we think objectively. The biases that drive the majority view may be many and varied and that is beyond the scope of this post (for a good introduction, search ‘Thinking Fast and Slow’).
A topical example for investors might be Tesla shares, which on any logical or intellectual basis are priced so that the slightest of upsets would result in very large losses for investors, yet professionals are still recommending purchases. In this case the main bias that makes you think you ought to join in the party is the FOMO one – the fear of missing out.
If you were asked ‘would you buy an investment that could lose 40% or more in a few days?’, I am petty sure you would say no, so objectively, you are not going to buy Tesla shares. But you may still wish you had. That is another aspect – the issue of regret.
I have one piece of advice for all investors. It is encapsulated in my guide to investing by way of a proper process and covers the early stages: know your objectives and how much you can afford to lose (your capacity for loss). After you have invested, when you are conducting reviews and when you are tempted to buy something, always run through those steps before letting the biases get the better of you! Un-bias yourself!