19th September 2013
While almost all investors recognise that past performance may not be a guide to future performance, relatively few have discovered how to pick the winning fund managers of the future. Investors have long tried to impose science on the process of manager selection, seeking a formula – analysts/experience x funds under management-squared or something similar – to find the manager most likely to deliver. But a new technology system claims to be able to identify the optimum conditions for a fund manager to thrive and therefore bring additional predictability to fund manager skill.
Investment journalist Cherry Reynard looks at the issues.
The new system has been devised by former hedge fund manager Clare Flynn Levy. It is a website – Essentia Analytics – that enables fund managers to input information about various ‘lifestyle’ factors such as where they were, their mood, what they’d just eaten, the time of day or whether they’d exercised when they bought a particular security. They can then determine the type of environment in which they made their best decisions and their worst decisions. Flynn Levy has already signed up Man Group and another major fund manager to use the site according to Ft.com
In the Financial Times David Oakley goes so far to suggest that the product, if successful, could bolster the case for active fund management over passive funds and trackers: “If fund managers can work out the ideal environment and circumstances for top performance…. then they should beat their benchmarks.”
Certainly the system would appear to be a powerful tool in the hands of investors, who could get a far more nuanced picture of fund manager performance, selling out if a fund manager’s circumstances change for the worst, or backing new managers who appear to have all the right conditions for top performance.
However, the system has some limitations. For example, it comes at a time when Richard Buxton, formerly a star UK Equity manager at Schroders and now head of equities at Old Mutual Asset Management, says that many fund managers are, “loners, weirdos and fruitcakes” as he recently said to Investment Week. This would seem to suggest that they are perhaps not the most reliable judges of their own behaviour. The system relies on them being honest about whether they were angry with colleagues, hungover, or fighting with their wife at the time of making the trade. It relies on them being honest about whether they have their best ideas in the shed. What if they make their best trades when they are miserable?
Another problem is how an investment manager would define a good decision. Is it simply a share that goes up? Over what time period? Is it a share that outperforms the benchmark index? Maybe the manager always favours oil stocks and they happen to have had a time in the sun. Is that a genuinely good decision? That said, perhaps it is simply down to the fund manager to judge whether ultimately the share price did what he thought it was going to do, and therefore fitted his criteria of ‘a good decision’.
Buxton does admit that a good understanding of human nature is vital to successful fund management: “The more you can understand human behaviour, the more you understand investors.” He goes on to say that that means that investment is an art, not a science, but this new system would simply seem to impose some element of science onto the analysis of human behaviour.
Many multi-managers already introduce some behavioural analysis when selecting fund managers for their portfolios. For example, Rob Burdett and Gary Potter, joint head of multi-manager at F&C Investments, have singled out the boutique structure as particularly conducive to good fund management and launched their global boutiques fund on that basis. Potter says: “Boutique businesses are usually established by small teams of fund managers with a good long term investment track records, who have the belief and conviction in their abilities and have usually left a larger investment house. They tend to leave because they get drawn into spending too much time on non-fund management issues and consequently not enough time on what matters most to clients – managing money.”
He believes that certain circumstances tend to promote good performance: a highly motivated and performance-driven firm; the fund manager usually has a large and significant stake in the fund or business so incentives and interests are aligned with investors; the freedom to invest without committee influence, plus working in a more flexible and appropriate working environment, ‘an environment which is largely free of politics and bureaucracy’. John Chatfeild-Roberts, head of the Jupiter fund of funds’ team, also makes no secret of the fact that he takes a fund manager’s personal circumstances and environment into account when investing.
Barclays Wealth says of picking fund managers: “Like science, the process should be formal, structured and repeatable to create comparative data points across institutions and asset managers. Like art, the process must be informed by a philosophy that guides our collective judgment as we integrate our objective findings in a creative way.”
It is clear that human nature plays a role in successful fund management. If the new system pinpoints that role more accurately, then it will have some use. It is likely to identify trends, but is unlikely to prompt a wave of fund managers working from their sheds if that is proved to be where the best decision-making goes on. Its problem is that it appears to depend on fund managers to be completely, and if their bosses and unit holders are watching, it may not provide much insight as a result.