Two funds that have been given a new lease of life.
Spotting great fund managers has always been difficult. Many investors tend to use the rear-view mirror – looking at past returns against a ‘passive benchmark’. That means they miss the forward-looking turning points, all important catalysts for future gain, and simply end up buying managers whose best performance is now behind them. So it’s no surprise that the whole idea of finding outstanding managers often turns into a debate about whether stock pickers can consistently win against passive funds.
But this misses a couple of key insights. The first is that not all active fund managers are the same. There are some giant asset management groups where the managers are simply going through the motions – claiming to provide wonderful stock selection but just delivering a fund that is a closet index tracker. This certainly isn’t the place to look for great managers.
Instead, it’s usually more rewarding to look among the smaller, independent “boutique” managers, as recent research from Affiliated Managers Group (AMG), an American fund manager, shows. In this study, boutiques are defined as being at least 10%-owned by the people who work for them, solely focused on investing as opposed to other financial services, pursuing a distinct investment philosophy, and managing less than $100bn in assets. According to AMG, these boutiques regularly outperform their bigger institutional peers.
The second important angle is that a change of manager can bring opportunities for alert investors. Far too many funds are zombies, where neither the manager nor the strategy has been refreshed in years. Bringing in a new fund manager can mean a new investment approach and potentially stronger performance. In other words, it can be a catalyst for a turnaround.
These situations, where the strategy noticeably changes under a new manager, don’t tend to come along often, but we’ve seen a handful of interesting fund transformations in the last few years. Perhaps the most interesting is Edinburgh Worldwide (LSE: EWI), an investment trust with a rather dour past but an intriguing future.
A redesign that’s paying off
Edinburgh Worldwide used to be an also-ran to its much bigger brother, Scottish Mortgage (LSE: SMT). Both funds are run by Baillie Gifford, a Scottish boutique manager, but Scottish Mortgage has been something of a star in recent years under managers James Anderson and Tom Slater. Its approach has been to pick large-cap growth stocks based around the idea of focusing on globally disruptive brands, often involving new technology. However, this approach inevitably ends up being focused on big global businesses, usually valued in the billions of dollars (Scottish Mortgage has around £2bn in assets under management).
It could be an even more interesting strategy to apply the same “disruptive” focus to smaller businesses, valued in the mere hundreds of millions. And that’s where last year’s redesign of Edinburgh Worldwide comes in. Under managers Douglas Brodie and John MacDougall, the trust’s £250m of assets are being used to pick up mid-to-small-cap businesses that are utilising technology shifts to build global brands.
The “redesign” wasn’t initially that successful. The new focus on smaller-cap global growth equities managed to catch a nasty sell-off in both tech stocks and riskier small caps. But recent numbers suggest that this fund is now coming into its own. The interim results to 30 April 2015 show a period of strong returns, with the net asset value (NAV) up 14.7% over the six month period, versus an increase of 10.4% in the S&P Citigroup Global Small Cap index and 11.0% in the MSCI World index, according to investment trust analysts at Numis. And performance has been strong in recent weeks, with the NAV up 6.3% since 30 April versus a rise of 0.3% in the MSCI World index.
Going for global growth
So what’s the appeal of this fund? First, it’s a way to play global equities via a simple portfolio with a strong growth bias focused on tech stocks and small caps. There’s no sector or country bias – it looks for good opportunities everywhere.
Second, you get the benefit of Baillie Gifford’s expertise in identifying globally disruptive businesses, via the Scottish Mortgage team. But with Scottish Mortgage you have to buy into an investment trust that is currently trading at a premium to its book value, whereas Edinburgh Worldwide is at a near 5% discount. If Edinburgh Worldwide continues to perform well, that discount is likely to vanish.
Importantly, you’re getting that management expertise at a very reasonable cost. The fund has an expense ratio of 0.92% per annum. By comparison, passive funds that could be described as having a focus on global growth sectors – although not exactly the same strategy – such as the iShares MSCI Emerging Markets Consumer Growth ETF, cost around 0.6% per annum. So you’re not paying much more than 0.30%-0.40% extra in fees.
Set against that, there are some very obvious risks. Edinburgh Worldwide is a global small-caps fund that invests in innovative growth stocks. That means that it holds many immature and expensive-looking firms.
For example, major holdings include outfits such as 4D Pharma (which is a UK-based biotech company developing natural bacteria-derived therapeutics), Xeros Technology Group (polymer bead-based technology for industrial cleaning), and Galapagos (a Belgian biotech company with a pipeline of drugs for inflammatory conditions, such as arthritis).
Newer holdings in the fund include Ilika, a British company that has developed a unique methodology for producing stackable solid-state lithium ion batteries, working in conjunction with Toyota. Another recent addition is Genmab, a Danish therapeutic antibody company focused on developing humanised antibodies to treat cancer.
There’s clearly a big healthcare bias here in the portfolio, plus a smattering of internet businesses and the odd hybrid business, such as MarketAxess, which is an electronic bond trading platform. You’ll even find outfits such as Stratasys, which sells 3D printers. These are all exciting technologies, but they are evolving quickly and there’s no guarantee that companies that are seen as leaders at the moment will be able to deliver on their promise and reward investors.
The portfolio is relatively diversified – it has 94 different holdings – but Edinburgh Worldwide is an extremely risky fund. It is certainly not an investment for somebody who is taking a one-to-five year view – it needs a long-term commitment. What’s more, many of the equity sectors within the fund are looking expensive (biotech, for instance). Given that, I have no doubt that in a big market sell-off this fund will be hammered.
So this is definitely not suitable for low-risk investors. But for those who can take the risk,you are buying into an exciting strategy through a fund still in an early stage of evolution, with a very clear stockpicking approach, from a boutique house that has considerable expertise in this area. So I think it could make a great long-term core holding for adventurous investors. Over the next few years, I’ll be watching carefully to see how Edinburgh Worldwide gets on.
How to pick the best trackers
Passive funds are increasingly recognised as a more cost-effective way to invest than most of their actively managed counterparts, writes Rory McConville. Active funds tend to have higher expenses and countless studies have shown that they underperform on average, after costs.
Passive funds are supposed to track an index as closely as possible rather than try to outperform it. The result is that, unless you are good – or lucky – at picking active managers who outperform, you are likely to get better long-term returns from a portfolio of cheap passive funds than one of expensive active funds.
As this message begins to resonate with investors, the amount of money entrusted to passive funds is rising: the Investment Management Association reports that UK passive funds saw their highest ever inflow in April. Yet it’s important to remember that not all passive funds are equally good – as recent figures from Chelsea Financial Services show. The firm’s biannual RedZone report, which highlights under-performing funds, has flagged up 20 passive funds that are consistently underperforming the sector average.
Among the worst culprits are Family Charities Ethical, which returned 9% less than its benchmark (the FTSE4Good UK 50 index) over three years, and L&G (A&L) Capital Growth, which lagged its benchmark by 5%. Collectively, these funds hold almost £20bn in assets, meaning that a significant amount of money is stranded in trackers that don’t seem to track very well.
These numbers are a stark reminder that you need to choose passive funds just as carefully as active funds. So what should you look out for when picking a tracker? First, check the fund’s costs. One of the big advantages of a passive fund should be low costs. Active funds tend to have ongoing costs of between 0.85% and 1% per year, which means that managers have to deliver a decent performance just to beat the market.
Passive fund charges may be 0.1%, or even lower. But some funds charge 1% or more for a basic FTSE 100 tracker – absolutely indefensible and a guarantee of underperformance. The second question is how well the fund tracks its index.
In theory, the difference between a passive fund’s returns and its index – known as the “tracking difference” – should be equal to the impact of fees. But this depends on the firm that runs the fund doing a good job – and some are significantly better than others. So look carefully at the fund’s past performance and choose one with a consistently low tracking difference.