by Mark Dampier
In each case, you need to find out more about why performance has been good or bad. This involves asking some of these kind of questions:
Has the fund manager made mistakes on either stock selection or asset allocation?
Is the investment style out of sorts with the market – for example, is the fund manager a value manager when growth is taking off?
Has a new manager been appointed with a different investment philosophy and style?
Is the group involved in a merger? This can often mean fund managers taking their eye off the ball as they are more concerned about their own jobs.
Has the fund become too large to be managed effectively?
Most of this information can now be found by digging around on websites, in newspapers and in the fund fact sheets you can get online through platforms. Most good websites now have charting functions that allow you to see how a fund has performed day by day, or month by month, over different periods of time. You can then compare that performance to that of other similar funds or the relevant market index. Some sites also include basic risk information, such as the volatility of returns – though not a perfect measure of risk by any means, volatility can be a useful indicator of how variable a fund’s returns are likely to be.
Digging out this kind of information and processing it does take time. Putting together the whole picture is what professional analysts like myself are paid to do. At Hargreaves Lansdown we do a lot of quantitative analysis, measuring the risk and style bias of each fund in great detail. We also have the opportunity to talk to fund managers directly, which is critical – as ultimately, even when you have analysed performance figures, you are making a judgment about the ability of the individual responsible for the fund. Experience in interpreting past performance is not something that you can teach in five minutes. If you want your investments to work harder for you, it does take effort. I give some examples of the material you can find online in the appendices.
Be wary of the numbers
One of the problems every investor faces is making sure that the performance data they are seeing is actually correct. We get ours both from Funds Library, a business which collects and distributes fund reports and information, and which we own ourselves, and also from other providers. In both cases we always like to keep checking that the information is correct. That is very hard for a DIY investor to do, as they don’t have easy access to, say, Lipper’s professional fund research, as we do. You can, however, get pretty comprehensive fund data from the likes of FE Trustnet, the Financial Times and Morningstar (quite often it turns out that the information all comes from the same original source). My colleague Lee Gardhouse, who runs our multi-manager offerings, says that he quite often finds that fund companies themselves have got their performance information wrong! Given how much data there is, this may not be entirely a surprise – but it is still a fact of life that we all have to confront.
It is also very important to make sure that you are measuring performance over a long enough period to be meaningful. I have suggested that you really ought to be looking back over at least ten years of performance before you can offer a definitive judgment on how good a fund manager is. Yet finding ten-year data on a public website is very difficult. Most charting packages, for example, don’t go back that far. It is equally important to track a fund manager’s performance over the length of his or her career. The longer a period of outperformance, the more credible it becomes. Figure 5.2 is an example of a very long-term track record, that of Adrian Frost, the manager of the Artemis Income fund. Before Artemis launched this fund, one of my favourites, in 2002, Mr Frost had several years running a fund with the same mandate for Deutsche Bank. (This information is taken from HL’s research for clients, and is not information that is visible in the fund’s own literature.)
Figure 5.2: Reconstructing a fund manager’s long-term track record. The example here is that of Adrian Frost, manager of the Artemis Income fund.
The 2008 financial crisis provided a classic example of how cycles can influence the typical kind of performance data that you see published. If you looked at the five-year data in 2012, the figures for most funds would still have looked terrible as the five-year period began just as we were about to go into a savage bear market. Yet by the time we reached 2014, the same funds were all showing handsome five-year performance, simply because the performance period started at the point that the market itself was recovering. The following charts give a couple of examples of this apparent dramatic turnaround in fortunes, again using Artemis Income as the example.
Figure 5.3: The track record of the Artemis Income fund, as it appeared in early 2012.
Figure 5.4: The same fund’s performance record, as it appeared in January 2015.
The first chart shows the performance of the fund from January 2007 to January 2012, as it would have appeared in a five-year chart at the time. The second chart shows the performance of the fund over a different five-year period: from January 2010 to January 2015. As you can see, there is quite a difference! The second chart paints a quite different picture to the first. What it tells you is a lot more about what was happening to the stock market as a whole than it does about the fund itself. (As it happens, the fund performed better relative to the market in the first period than in the second, as you can see if you chart the whole period against the performance of the UK stock market.) So don’t be taken in at first sight by how well a fund has done.
The reality is that you can prove almost anything you want if you are careful to choose the most favourable basis for your data. That is one reason why the regulators now insist that all performance data must be presented in a standardised format, although even they still say that five years is a long enough period. Newspapers are particularly prone to falling into the trap of quoting out-of-context performance numbers so as to make a good story. They are particularly fond of reporting that such and such fund manager is a new star of the industry, or alternatively has lost his touch, all based on one poor period. It even happened to Anthony Bolton, one of the most successful of all postwar UK fund managers, when he came out of retirement to run a Chinese fund in Hong Kong for his company Fidelity.
Using charts to analyse performance
Looking at performance charts, as I have suggested, can be a very helpful tool in trying to understand what funds have done and how one fund differs from another. Until quite recently customisable charts weren’t readily available to the amateur investor. You could find tables of fund performance in specialist periodicals such as Money Management, but that was it. The internet has changed all that. These days there are scores of charting services on fund websites and all the best platforms allow you to compare funds this way. What is more, the range and quality of chart options are improving all the time.
Charts are useful because they can paint a much clearer picture of performance over time than data in a table. You can see in detail how a fund has done over a period of years – the scale of the returns, when it has outperformed and underperformed, how volatile the performance has been, and so on. It is a great way to compare funds as a good chart brings out the important differences in one simple and easy-to-grasp image. You can also compare a fund’s performance against general market indices and the average performance of funds in its peer group. I have found them invaluable when answering investors who have asked why such and such a fund that appears to have done well is not on our list of recommended funds.
Once or twice the answer may be simply that we have missed a good fund, which is always possible, given how many funds there are out there. More often than not, however, I find that investors who think they have a fund which is superior to one of our own choices haven’t really done sufficient homework to understand its real characteristics. Looking at charts would have made it easier for them to see the real picture. The chart below makes the point with a real-life example.
Figure 5.5: A worl
d of difference – two Japanese funds compared.
It compares the performance of two Japanese funds, one managed by Legg Mason and the other by a company called GLG. The latter seldom appears near the top of the performance tables, while the former has been number one more than once. But which one do you as an investor really want? Clients often ask why we are not backing the Legg Mason fund. The chart gives you the answer. You can see how the Legg Mason fund made some huge gains in 2003, 2005 and 2012. If you had timed buying it at just the right moment, you would have made some spectacular gains.
But look also at how dramatically the fund fell from its peak in 2005. It was five years before it once again shot to the top of the performance table, seemingly from nowhere. The GLG fund meanwhile has been making a more prosaic journey. While it has rarely topped the short-term league tables, it has never suffered the same sharp falls either. Over the longer haul, it has been the better and more consistent performer. My conclusion is that the GLG fund is the one that I would rather own.
Note that you might never have known all this if you looked only at current performance numbers. There is a particular trap in looking at one, three and five-year cumulative performance figures. At any given point in time, such as those dates when Legg Mason Japan was shooting out the lights, all the cumulative numbers can look remarkably good. But it is important to look a bit closer. What year-by-year figures lie behind the strong cumulative performance? It may be that they reflect just one great year out of five – the most recent one. The chart will show you the real picture.
Of course, you might also draw a different conclusion from this chart. You may think that all you need to do is buy the Legg Mason fund when it is near the bottom of the performance table and sell it after it has made one of its occasional spectacular gains. Nice idea! By all means try it if you must. But don’t expect me to back you to be able to do it. I wouldn’t back myself to make that kind of timing call and all my experience suggests you won’t be able to do so either.
Figure 5.6: Making sense of the picture – two income funds compared.
Here is another example of the kind of insights that a chart can give you. It shows the performance of two well-known income funds, Unicorn Income and Invesco Perpetual High Income, from 2004 until the present. As it happens, both these funds have recently lost their fund managers – sadly, in the case of the Unicorn fund, as a result of the death of John McClure, and in that of the Invesco Perpetual fund, Neil Woodford’s decision to leave the company to set up his own fund management business. For most of the period both funds were classified as equity income funds by the industry trade body (although for daft reasons which I won’t explain here, the Invesco Perpetual fund now finds itself in the All Companies sector).
You can see that overall both funds have done very well. But note also how the journey the two funds have taken has differed. From 2004 until 2009 the Unicorn fund lagged the performance of the Invesco Perpetual fund. Then it suddenly started to rise strongly from the bottom of the bear market in 2009. Since then it has easily performed as the better of the two funds as well as becoming one of the very top performers in the equity income sector.
How to explain that turnaround in fortune? Well, John McClure was always a good manager, well-connected and with bags of experience. What made the real difference was that after 2009 there was a huge rally in small and mid-cap stocks, one that broadly lasted until March 2014 and during which they easily outperformed large-cap stocks. It was this change in investment style which explains most of Unicorn’s superior performance over this particular period. Being so much larger, the Invesco Perpetual fund inevitably had more invested in large-cap companies. There was no way that it could have matched the performance of its smaller counterpart.
Does that make it a worse fund? No. The conclusion I draw from this chart is different to the first one. While the two funds have a similar objective, the way they operate guarantees that they will fare differently in different market conditions. When small-cap stocks do particularly well, so too will the Unicorn fund. When large caps are in the ascendant, it is the Invesco Perpetual fund which is likely to outperform. None of this is difficult to grasp, but investors have to do the work to find out what is going on under the bonnet of a fund.
Charts help enormously in this respect: comparing the performance of these two funds with, say, the FTSE 100 index (as a proxy for large-cap stocks) and the FTSE All-Share or Smaller Companies indices would have quickly brought the different nature of the two funds. Unless you feel you have the skills to call the turns in investment styles, which is generally no easier than calling the tops and bottoms of bull and bear markets, it is not a bad strategy to have more than one equity income fund, each one with its own different style. I comment on this further in chapter 7.
Keeping it simple
As a performance track record can always hide things, what you want from a fund manager is a consistency of style and approach. The other day I was asked by an up-and-coming young fund manager what he should do to convince me that he had the makings of a top professional. I said, “You’ve got to be able to sit down and tell me what you do and what your philosophy is in no more than five minutes.” It should be fairly simple. My experience over 30 years is that if the approach sounds complicated, and you have to go into a dark room and hit yourself over the head to try and understand it, then you shouldn’t touch it.
In fact, if I had just one piece of advice to give anyone, it would be just that: keep it simple. What has enabled me (touch wood) to avoid most of the really bad investments I have come across over the years in financial services is recognising that complexity is normally a red flag. Investment isn’t really that complicated, although a lot of professionals try to make it as complicated as possible in order to impress you with how clever they are. Neil Woodford is very good at communicating his simple philosophy and latest ideas. It is easy to understand what he is saying and he says it in about three minutes flat.
The ability to articulate what you do, simply and consistently, is what I am looking for when conducting face-to-face interviews with fund managers. I always write up my notes and do further analysis, but at heart that’s what I am really after. The fund managers should be able to tell me very quickly what they do and why. Everyone can say something like, “We look to buy quality companies”, and while that may sound like a great line, so what? Who is out there actually looking to buy rubbish? What we have to do is get underneath the surface and say, “What do you mean by a quality company”? The best fund managers make what they do sound like simple common sense. The ones who try to sound brilliant, usually from Oxford and Cambridge by the way, often make it more complicated for themselves!
Although it is not easy for DIY investors to get to meet the best-known fund managers in person, there are plenty of video interviews around these days so that if you start looking you can usually get to see what the person running the fund you are interested in has to say for themselves. HL carries a number of them on our website and you can also try websites like Trustnet, Morningstar and Interactive Investor. That way at least you can form a picture of what sort of person is handling your money and how well they present themselves and their story – though always remember that they will have been trained to be polished in front of a camera. (Some of them are frighteningly young, too, but most do look a bit older than the pictures in their promotional material when you meet them in person – funny that!)
All funds are required to produce regular factsheets to summarise their performance and their most important holdings. This is a useful starting point, and will include a list of the ten largest holdings and breakdown of the fund’s holdings by sector. Many of the biggest firms offer visitors to their websites the facility to get email alerts about important announcements and the views of their managers. It is also possible to read the interim and annual reports of any fund. These usually have much longer pieces of commentary on a fund’s
objectives and performance, as well as a full list of all the holdings that a fund owns (not just the top ten). The reports produced by Artemis are among the best in this respect. Statutory reports are a very valuable information source, and one that surprisingly few investors seem to know even exist. You should definitely look for them and read them.11
Stick to the discipline
Once we have decided to back a manager, our primary objective afterwards is to try to make sure that they are sticking to their discipline. It is when people start to go off on a different course than the one they set out on that it starts to get dangerous. The technology boom in 1999–2000 was a classic case. For a while the craze for investing in anything vaguely tech-oriented was such that fund managers knew their careers could be lost if they failed to change course and start following the herd.
Our question to fund managers at the time was: “If you have told us at the outset that you are a disciplined value investor, only buying stocks that were cheap on valuation grounds, why are you suddenly rushing off to buy some whizzbang new company whose valuation breaks all your own rules? You wouldn’t have touched it with a bargepole before.” If that sort of thing happens, you know that it’s all going to go wrong in the end. So anything like that is an automatic sell signal for us.
What about funds that use derivatives, which the great American investor Warren Buffett once memorably described as “financial weapons of mass destruction”? Is that a good or a bad sign? I am not necessarily against funds that use options or futures in their strategy. It all depends on how and why they use them. If the aim is simply to insure a portfolio against the risk of a severe market fall, for example, I don’t mind it. Bond managers use derivatives a lot more than equity managers. Sometimes it is to get exposure to a particular type of bond or market very quickly, and that can make sense. Hedging currency exposure is also often a sensible idea.
