Disclosure – Non-Independent Marketing Communication
This is a non-independent marketing communication commissioned by Alliance Trust. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.
For ordinary investors, choosing a fund can be a major challenge. We are told that past performance is not a guide to future returns, but it can be very tempting to ignore that advice and for many this is the first point of call (in our view erroneously) when it comes to deciding where to invest their hard-earned savings.
Clearly, a strong track record has its appeal, but a rigorous approach to choosing a fund – considering more than just the returns it has delivered and looking more closely at the people behind it and understanding the qualitative factors which underpin their approach – can mean the difference between success and failure.
Willis Towers Watson (WTW) is responsible for choosing the fund managers who run the underlying funds for Alliance Trust (ATST), a £3bn investment trust which offers a diversified and actively managed exposure to global equity markets.
With a universe of 16,000 potential asset managers to choose from, WTW uses its considerable resources and expertise to narrow down that list to 20 potential managers, from which the final ten – who currently run the trust’s underlying portfolios – are selected; blending their styles to ensure each complements the others.
We asked them for some tips on doing the job properly…
WTW place a great degree of emphasis on the culture of the companies they choose as asset managers according to global head of manager research Chris Redmond, who says “Understanding the culture of organisations, the alignment between different stakeholders and how they manage to create effective teams that are capable of developing and evolving” is essential.
“We believe culture is a unique ingredient and the bedrock on which a competitive advantage is sustained over the long term.”
WTW prefer to partner up with asset managers that are comfortable running concentrated mandates (not all are), have a longer-term horizon and look at risk as a permanent loss of capital as opposed to the risk relative to the benchmark.
The calibre of the people, and the resources they have access to are one factor to consider here, so evidence of a long track record (not just a strong one) of investing in the same investment area is worth looking for.
Another key area of interest here is the structure of the management. WTW says evidence of succession planning – which ensures that a fund is not left in a precarious position by, for example, a senior manager’s departure, is a definitive part of the evaluation.
The stability of the team behind the fund is another key point. Understanding how the team is incentivised, and rewarded for success, can help to identify managers whose interests are aligned with those of their investors, and a high turnover of key staff can signal instability which could ultimately affect returns.
Research and resources
Analysis of the market in which a manager operates – and particularly any structural headwinds that they may face – is a good starting point before one moves on to examine the resources which they have access to when it comes to making money in that market.
Understanding the resources that a fund manager has access to helps to establish the competitive advantage that they might have, which is a crucial element of success according to WTW, but a large team of analysts isn’t necessarily evidence of a superior manager. WTW say: “It is not only the resources but also their investment style, capacity, what area of the market are they playing in and are these likely to face any structural headwinds going forward impacting the competitive advantage.”
WTW identify the stock picker who run the Alliance Trust portfolios via proprietary research and, while the underlying managers may use broker contacts and research from time to time, most of them rely on original, proprietary research produced by their own teams.
Bill Kanko, founder and president of Black Creek Investment which runs 11% of the ATST portfolio, illustrates the point: “We have to have a view of a company that isn’t shared by everyone else because if everyone knows it’s a great company then that will be in the price. We need some unique insight into the company which enables us to say it is going to be much bigger and more profitable in the future, to the surprise of other investors.”
Is the investment process clear?
A key ‘red flag’ for investors should be that a manager does not appear to have a clearly defined philosophy because, without one, there is no way to prove that any previous success was not more a matter of luck than strategy. WTW look for a competitive advantage in the way the team manages ideas, a clear ability to turn ideas into investments, a clear and defined approach to ESG, and a philosophy which is compelling and consistent with the resources and skillset which is available. Making sure that the manager sticks to the process they have defined, once the fund is in your portfolio, is equally important; WTW say they are looking for evidence that the manager is thinking about risk and portfolio construction all the time.
Portfolio construction has a significant impact on performance.
A very high number of holdings can offer the benefits of diversification, but can make it difficult for strong performance from any single holding to make much difference to the overall portfolio return – muting performance overall.
Concentration is also important. A high conviction, focused portfolio can offer superior ‘alpha’ because the performance of each individual holding is less diluted, and this is the route WTW use to support Alliance Trust.
“We aim to increase expected returns by maximising exposure to stock pickers’ stock selection skill. We do this by instructing them to run concentrated, unconstrained portfolios with very high ‘active share’ (active share is a measure of how different the portfolio is to the benchmark) with only 10 to 20 stock ideas in each mandate.”
However, WTW’s expertise, and consistent monitoring, is important here because the same effect can also magnify downside if stock selection is poor.
Everything is relative, unless it isn’t
Understanding your fund manager’s approach to the benchmark is fundamental to understanding what you might expect from the fund in terms of performance. Some funds are managed with a ‘benchmark agnostic’ approach, meaning they are managed with little regard for what the index is doing, while others are managed with a ‘benchmark aware’ strategy – which means their managers will have limits imposed on their exposure to stocks and sectors designed to ensure the fund they manage remains aligned with the performance of the benchmark in question.
Benchmarking is a contentious issue. When the index is flying ahead investors tend to complain loudly if their manager is not keeping up with it. During negative phases, investors tend to prefer that their managers ignore the benchmark completely. It is important to understand the manager’s approach before you invest because if a manager does not pay heed to a benchmark, you may find yourself in a position where the fund is not keeping pace with the market in which it invests – and this may be for good reason if the manager is able to explain their reasoning (see investment process).
WTW manage Alliance Trust using the MSCI All Country World TR Index as a reference point against which to benchmark the overall portfolio’s performance, but they do not expect the underlying managers to feel restricted by benchmark constraints. Instead – to maximise the impact of stock picking – they allow the underlying managers to choose a focused portfolio of ‘best ideas’ while WTW manages the overall portfolio risk and asset to ensure a diversified exposure with no significant style, sector or country biases relative to the benchmark.
Choosing an investment is a complicated process and these five points only scratch the surface.
Other issues to consider include size – and its impact on liquidity – the nature of a fund’s underlying shareholder base, currency exposure, gearing, hedging, and charging structure, for example.
The latter is particularly important given the significant impact it has on a managers’ ability to add value – after fees are taken into account – and there is very little an individual investor can do to negotiate fees down. WTW are able to use their scale and relationships with the managers to negotiate very attractive fees, meaning the Alliance Trust portfolio is available to shareholders at a very attractive OCR.
These factors ignore the macro issues beyond the fund itself which must also be considered – the state of the economies to which a fund is exposed, the interest rate environment, valuations in the assets in which the fund invests etc., and a typical ‘due diligence’ report for a professional investor considering an investment can easily run to 10,000 words.
All of these things must then be monitored on an ongoing basis, once the fund has actually made it into your portfolio.
Willis Towers Watson are one of the leading institutional investment consultants globally, with $3.41 trn assets under advice and a research team of some 108 people. For many people, with busy lives and many responsibilities aside from looking after their investments, relying on the expertise and resources of a team like this – and accessing it through an investor-friendly wrapper like Alliance Trust – might be the more straightforward option.
1AUA as of 31 December 2019, latest data available. AUM is $183.5B as of 30 June 2021.
Login to read the full article...
Kepler Trust Intelligence provides research and information for professional and private investors. In order to ensure that we provide you with the right kind of content, and to ensure that the content we provide is compliant, you need to tell us what type of investor you are.Continue