Rather than take bets on individual fund managers, long-term investors are then better served with a low cost index fund that tracks the broad market return. But for many institutional investors, this is just too simple; they would rather spend heavily on advice and fund manager analysis, in the hope this will give them an edge. Warren Buffett spoke about this very thing in his 2016 Annual Letter to Shareholders, lamenting the billions of dollars that these “special needs” clients waste, trying to earn superior returns.
However, even this approach is governed by one over-riding rule that long-term investors MUST apply: have a well-considered investment policy and stick to it; and if you trust your fund manager’s staff and processes, then stick with them too.
But even industry professionals have a hard time following through, when other strategies appear to be working better. They are human after all, and we are all prone to ‘lane changing’ syndrome. Stuck in bumper-to bumper traffic on the highway, we see the other lane moving faster. We think it’s temporary, but it keeps moving ahead. We resist and resist…but eventually we succumb and move across. It is usually around this time that this lane grinds to a halt, and your original lane accelerates.
Despite good intentions, we make the same mistake with our money. We cling to a misfiring strategy, then cave in at the worst possible time. It is the classic ‘sell low, buy high’ road to investment failure. Because invariably, what has moved ahead, is now fully priced, and what lagged behind now offers good value.
A case in point is Nedgroup Investments Managed Fund (NIMF). It uses a “Best of Breed” approach, using five “top” managers to look after its branded funds.
ReCM was one of these fund managers. It follows a “deep value” investment philosophy, but such shares had been so out of favour since the Global Financial Crises that by September 2015, ReCM was the worst-performing fund over one, three, five and ten years.
After holding on for many years, NIMF finally decided to pull the plug, despite being well aware of the heavy cyclical component to this performance, and the risk of poor timing.
Instead they brought in Truffle, because “we particularity like businesses that are owner-managed, where the management of the firm invests alongside investors; businesses that are willing to limit the size of their assets to get good returns; and fund managers that have proven long term track records.”
Of course, all these characteristics apply equally to ReCM; what separated these two at the end of September 2015 was that ReCM was ranked last over three years, and Truffle was ranked second.
Almost all commentators agreed that this was the right move. ReCM was the architect of its own downfall, they said; the company should not have stuck so stubbornly to its “deep value” investment philosophy.
Roll forward one year, and ReCM now tops the one-year balanced high equity ranking table, with a one-year net return of 22,3% (to December 2016). Truffle, on the other hand, returned -3,2% and ranked 147 out of 165. NIMF has well and truly locked in those ReCM losses. How long until the market turns in Truffle’s favour? Nobody knows. How long will NIMF stick with them? Only they can say.
The bottom line is this: among active investors, only those with strong investment beliefs and a clearly defined investment policy, who rigorously stick to their script, are likely to prevail and deliver an acceptable long-term return.
So if you don’t trust your fund manager to deliver on this, then don’t choose them. If you don’t get this conviction with any fund manager, use index funds. In fact, even if you are convinced, use index funds, because you could be wrong, and you have a (far) less than even chance of picking a winning fund manager.
At least you will then have the comfort of knowing that if returns are poor, it’s the market, not your manager. And you know the market will bounce back. Also, you won’t be tempted to jump ship at the worst moment, at the risk of wasting your clients’ money and becoming the laughing stock in the market.
