Fund pickers using a quantitative screen as the starting point to selection serve only to make big funds bigger and are likely to buy into these strategies just as performance is on the way down, according to Cazenove Capital’s head of multi-manager, Marcus Brookes.
Citing studies he had done using Lipper data, Brookes said the probability of a top performing fund over three and five years maintaining its performance in the next three to five years was minimal.
Looking at sectors from Asia Pacific ex-Japan to UK Small mid-cap Brookes found that if a fund was first quartile in the three years to 31 August 2007 there was less than 15% probability it would remain first quartile in the subsequent three years to 31 August 2010.
GEM funds were particularly inconsistent with none of those that achieved top quartile during the first time period holding onto it in the second.
Meanwhile, only 4% of Apac ex-Japan funds achieved top quartile performance over both time periods, as 8% of Europe ex-UK and 9% of UK equity funds managed the double whammy.
Perhaps surprisingly, UK small cap, seen as one of the more volatile asset classes, had just under a 14% probability of ranking in the first quartile at the end of the second period after doing so in the first.
Contrarian fund investing
If the timeframes are extended to five years the picture is no better, with no sector achieving higher than a 13% probability of top quartile performance over both periods.
“There’s no real consistency to buying something and sitting on it,” said Brookes, “If I were to describe some fund managers’ and IFAs’ approach to picking funds It is usually quantitative to begin with and it is obvious most guys begin with the stuff that has just done well.
“A lot of people doing this are buying high and if it has just outperformed maybe it is because it is a highly cyclical growth fund or a value fund and that is why it has done well in the previous period. It also means you are discounting three-quarters of the sector.”
Instead Brooke said pickers should be looking at funds that have just done really, really badly but are managed by somebody that can turn that performance around, admitting his approach could be called 'contrarian fund investing'.
This requires looking at the underlying holdings within a fund and making asset allocation calls about whether the fund manager’s portfolio is due to bounce back from a period of underperformance.
An alternative is to buy and hold a fund run by a manager willing to change their asset allocation at the right time, to the right thing, but Brookes believes most managers have prejudices, biases and preferences that prevent them from changing their core views often enough to protect them from the downside.
Manager substitutions
Last year Brookes’ multi-manager portfolios had holdings in some well-known names such as Invesco Perpetual’s Neil Woodford, First State’s Angus Tulloch and Findlay Park’s James Findlay.
He has now either sold out of these managers or is starting to let holdings dwindle, while he buys into out of favour managers such as Fidelity’s Sanjeev Shah and Cazenove’s own head of Pan-European equities, Chris Rice.
Currently Brookes is keeping a significant portion of cash on the books, which he said is to counterbalance volatility in holdings in European and Japanese equities, but within the next six months he “fully expects” to put this cash to work.