Persistently skilled fund managers are a very rare commodity, hard to identify in advance and hard to live with over time. Anecdotes and examples of great managers are often used to justify active management, yet even some of the truly ‘great’ managers have failed to live up to their billing. Like the laws of physics, where many big stars eventually reach their evolutionary end in a supernova, the rules of efficient markets, the zero-sum game where losers must fund winners, investment costs and poor investor behaviour have a similar impact on those labelled as ‘star’ managers. Here are some examples of fading stars.
Bill Miller of Legg Mason outperformed the S&P500 fund 15 years in a row from 1991 to 2005, returning just over 16% p.a., which compared well to the US-based Vanguard S&P500 index fund’s return of a little over 11% p.a. Investors in his fund only achieved a return during that period of just over 11% p.a.¹. Roll forward and the story is very different. Bill Miller had a disaster during the Credit Crisis, after changing strategy and investing the fund heavily in bank shares. He lost around 70% of the value of the fund in three years. The fund recovered poorly, and he retired as its fund’s manager in April 2012. Over his entire tenure as manager of the Legg Mason fund (5/1982 to 3/2012) the fund returned almost exactly the same as the US-based Vanguard S&P 500 index fund.
Anthony Bolton, after retiring from the Fidelity Special Situations fund with a strong track record in smaller company value stocks set up an investment trust investing in China. The latter was a very chastening experience for him and a tough ride for his investors. He retired altogether in 2014 stating ‘I was wrong about the market in China’², having tarnished his golden reputation.
Neil Woodford – as anyone who has been reading the paper lately would know – has suffered a humiliating and effectively career ending demise, as liquidity problems associated with holding privately held companies in his Woodford Equity Income fund spiralled out of control. He and his business partner are estimated to have taken dividends from the firm of around £100 million.
Warren Buffett does not escape comment. Over the past 10 years to the end of 2018, Berkshire Hathaway – Buffett’s holding company – has turned US$10,000 into US$32,350 whereas the S&P 500 index of US stocks delivered US$34,225³. Even the ‘best of the best’ can struggle against the relentless market. Capturing the market return is a worthy goal as he himself often points out by recommending index funds as a sensible investment solution.
Investors today are lucky. They can invest in low cost, diversified systematic (disciplined, rules-driven) funds that seek to capture specific risks in the market which are expected to deliver higher returns than the market, such as the premium associated with smaller companies or those of value (less healthy) companies. Identifying the best-in-class funds and living with them over time becomes far easier. It takes away the risk of attaching the success of your investment programme to one or a small handful of stars, who may well become supernovas. Remember that over a 15 year period, around 6 in 10 funds cease to exist.
The key conclusion of this short note is that although there may well be some skilled managers to invest with, they are few and far between, are difficult to identify in advance and very difficult to live with. A real risk exists that you may be wrong, which in cases such as Woodford can have very real financial consequences. In today’s investment space, taking these risks is unnecessary, stressful and the odds of them paying off are low. If you stick to sensible market risks captured by systematic funds, then sensible longer-term returns should follow. Don’t be blinded by the light of a supernova.
1 Allan Sloan (2011), Bill Miller had a great run, but did his investors? www.fortune.com
2 Bradley Gerrard (2014), Anthony Bolton: ‘I was wrong about China’ www.ft.com
3 Berkshire Hathaway Letter to Shareholders 2019