The investment management industry has had to overcome several obstacles in recent years – most notably the RDR and the active versus passive debate.
In recent years we have also witnessed a series of ‘star’ fund managers delivering below-par results.
Many traditional asset managers have failed to deliver for clients in recent years, which has created headaches for advisers and fund selectors.
However, there are a number of questions intermediaries can ask to try and ascertain whether a manager has the capacity to deliver market-beating returns.
The first, and probably most important, question is simple: ‘what level of outperformance do you target?’.
At Blue Whale, we believe every active manager should be aiming to deliver outperformance of at least 5% to justify their fees. Some may believe this is undeliverable, but this is only because the investment management industry has lowered its expectations in recent years.
The importance of a high-conviction ‘best ideas’ portfolio
For an active manager to deliver outsized returns it is pivotal to run a concentrated portfolio.
Regardless of a manager’s perceived skill, a portfolio with more than 35 stocks is statistically unlikely to deviate far enough from the index to deliver superior performance.
A smaller number of high-conviction positions should indicate the manager is focusing on true best ideas, without the need to populate a portfolio with under-researched stocks.
Each investment thus has a material impact on the performance of the fund, which forces the manager to agonise over its potential inclusion into the portfolio.
However, successfully running a concentrated portfolio requires a great deal of research into each company. This is the most important element of managing an investment strategy.
When you consider many portfolio managers act alone in generating ideas – or sit alongside just a single co-manager or analyst – it does call into question whether this research is adequate.
To truly understand companies, it is necessary for investment teams to be far more resourced than is often the case. Therefore, it is important to question a manager about the size of the investment team.
The dangers of sell-side research and meeting executives
It is usual for under-resourced managers to rely on two common practices – both of which we are sceptical of at Blue Whale. Firstly, there is the reliance on sell-side research.
We question the value of this research due to its ubiquitous nature. Managers simply cannot obtain an edge over competition by utilising research that is widely available to anyone willing to pay for it.
In fact, most managers have identified the providers offering the industry’s leading research. Therefore, even the best sell-side research does not provide an advantage, as it is likely to be the most consumed.
The introduction of Mifid II at the beginning of this year shone a spotlight on vast swathes of managers dependent on sell-side research.
While the focus of this legislation was on how research was paid for, it poses another question: ‘should a manager be charging a management fee if there is no independent research undertaken?’.
In fact, the cost of third-party research has plummeted since Mifid II, further highlighting its limited value in stock selection.
The importance of meeting company executives in the research process is another claim many fund managers make.
However, we are sceptical, as there is little company management can disclose. Any information not in the public domain would be considered insider knowledge, which is obviously illegal.
We have seen countless examples of corporate bosses painting a rosy picture just weeks before the business issues a profit warning or unveils a poor set of numbers.
At Blue Whale, our foundations are built on in-house research. The team behind our sole strategy currently comprises of two fund managers and three full-time analysts.
This allows us the confidence to run a concentrated, high-conviction portfolio of 25 to 35 stocks.
Our edge is powered by getting fully under-the-bonnet of each company, with the aim to uncover insights likely to result in a re-rating of the stock price before the competition.
In the 12 months to the end October Yiu's LF Blue Whale Growth fund which launched on 11 September, has returned 9.7% versus a peer group average of 1.2%.