Fund buyers spend their time rooting out good funds and will come across funds that are demonstrably poor. This is no surprise; not all funds can be better than average. Most funds are unremarkable in nature and destined to be also-rans. But, occasionally, a fund leaves us with severe doubts about its qualities.
I have previously highlighted the features of good funds; this article highlights bad approaches to investment management.
ABC Inc was an international banking conglomerate that had acquired a collection of disparate asset management businesses. The London business was relatively small but had some of the best funds in their sectors. In an attempt to justify the high prices paid for these, ABC decided to rationalise the firm and utilise a cutting-edge IT platform used by the large US analyst team.
But the US division was reeling from an ill-conceived merger between two culturally incompatible asset management firms. Many of the best analysts had moved on and the unit’s output was deteriorating. The high-grade analyst teams supporting the London operations were deemed surplus to requirements. The assets began to evaporate.
Eventually the entire UK fund range was closed. The lesson here is that the environment in which fund managers sit is important. Asset management businesses do not function well in firms with hierarchal structures, and what are seen as apparent cost centres can be critical elements of the value-add chain.
Manager XYZ had recently been promoted to head the firm’s US equity fund. Typically when interviewing fund managers, I ask them to talk me though their risk controls and systems. It became evident this manager did not understand how his risk systems worked. He conceded his risk report was brought to his desk each morning and this informed his portfolio construction. Good managers have high levels of intellectual curiosity that is reflected in every facet of what they do. This particular manager went on to deliver disappointing results.
Life company DEF had a nice distribution niche, generally targeting relatively unsophisticated investors. The business resources went into its distribution arm and the quality of the investment division was seen as secondary. The DEF funds were expensive, typically run as closet index-type strategies and tended to rely on street research. Even on a gross basis the funds repeatedly underperformed. Doing better than average requires a differentiated approach and often exceptional individuals – both sadly absent in this firm’s investment division.
Manager UVW had taken control of a small sector-specific fund. The sector suddenly took off. Although technically proficient in his own field, the manager lacked the experience and wider knowledge of the markets. When the inevitable turn came the manager struggled emotionally to deal with the consequences and after an extended period of sick leave left the industry. Investors should not confuse impressive performance with investment expertise.
Asset Manager GHI had a well-run US fund with a solid team of analysts. When the lead manager left, his ambitious young deputy took charge. Initial success led him increasingly to disregard the investment process and his arrogant approach began to create friction in the team. After a period of sustained underperformance he was fired. Good fund managers tend to be humble and conscious of the power of markets.
Fund LMN was an open-ended fund investing in European residential property. It was unregulated and was permitted to borrow, which it did extensively. Typically, the fund operated with four parts debt to one part equity. Management fees were of course charged on the gross value of the property assets. Despite the fund only dealing on a monthly basis, the liquidity mismatch eventually caused it to come a cropper. It suspended trading and never reopened. Identifying bad practice can help to remind us what makes good managers good.