Fund managers’ failure to focus on actual investing is letting clients down.
Iain McCombie, partner at Baillie Gifford in Scotland, says nowadays fund managers are often perceived as cigar-smoking individuals who only care about how much money they can make for themselves.
“And we don’t help ourselves,” he told financial advisors at a Glacier International investment seminar. “My industry is obsessed with abstract concepts and complexity. The truth is most of it is utter nonsense – and worse than that, success for many fund managers is not client outcomes that you [advisors] are worried about, it is trying to marginally outsmart their peers. That is not investing. That is playing a zero-sum game.”
Data arms race vs actual investing
Many active managers are participating in a data arms race, claiming that their analysis is better, faster and smarter than anyone else’s, he adds. The question is whether the average fund manager or CEO puts their clients’ interests above short-term profit targets.
McCombie says this is where actual investing comes in. Actual investing is about identifying and backing fundamental investment ideas.
“It is a very simple concept but very profound,” he says. “But the reason why most investors don’t do this is that you’ve got to be prepared to ignore the stock market noise.”
McCombie cites one such example – the Australian company Cochlear, which makes implants for deaf people. Baillie Gifford has held shares in the company since 2009.
It’s not about the figures
Actual investing is not about the share price or the dividend, but about the product, trying to understand why people like the company and what the opportunity for the business is, he says.
While McCombie believes Cochlear has been a successful investment, the market did not necessarily experience this. Between January 1, 2009 and August 31, 2018, there were 3 483 Bloomberg headlines published on the company and 474 analyst target price changes.
Instead of worrying about buy and sell recommendations related to Cochlear and half-year results, he believes it is important to meet with management to understand what is going on in the firm, to speak to surgeons and representatives of the deaf community, attend trade shows, meet with the competition and visit the research and development centre. This is not about looking for a silver bullet but about understanding the opportunities and threats for the company.
But would actual investing still work at a portfolio level?
Research conducted by Martijn Cremers of the University of Notre Dame and others looking at the performance of equity-only mutual funds (unit trusts) in the US between 1990 and 2003, and 1995 and 2013, showed that the after-fee average excess returns of these active managers against the benchmark was -0.4% per annum.
The 20% of this universe who had the highest active share (those fund managers who were the most different from the benchmark) did better, and generated an after-fee average excess return of 1.1% per annum.
Within this smaller universe, an analysis of the performance of the 20% managers who had the highest active share and the highest portfolio turnover showed that they had an after-fee average excess return of -1.9%. In contrast, the 20% with the highest active share and lowest portfolio turnover generated an after-fee average excess return of 2.3% per annum.
To determine whether fund managers are actual investors, McCombie believes there are three key things investors can look at – a high active share, low portfolio turnover and an appreciation of cost.