A SKY FULL OF STARS?

What lessons can we learn from the Woodford debacle? Brian Tora reflects on the rise of so-called ‘star’ fund managers and the importance of effective due diligence when it comes to fund analysis and selection

If there was one theme that was prominent in the dying months of last year and as the new decade got underway, it was the rise and fall – and the role – of the so-called star fund manager. While the rapid descent of Neil Woodford has probably been the most talked about development in this area, the significant sums earned by the most successful fund managers has also thrown a spotlight on the increasing power some of these players now have in the retail investment market.

Of course, the concept of star fund managers is far from new. There have been plenty to whom this description

Not all fund managers who have aspired to star status have managed to stay on track through thick and thin

could be reasonably applied in my lifetime and more than a few that could have earned this accolade in the early years of the professional investment management industry. Arguably one of the first was Benjamin Graham, considered the father of value investing. Although he was an American investor, he was actually born in London towards the end of the nineteenth century.

Many will consider Warren Buffett a star fund manager, even if his Berkshire Hathaway company is hardly a conventional retail fund. These are people who have maintained their reputations over the years, but not all fund managers who have aspired to star status have managed to stay on track through thick and thin.

FALLEN STARS

Anthony Bolton, the highly regarded manager of the Fidelity Special Situations fund during the 1980s and 1990s, found the transition to managing a fund investing in China a tricky business.

I recall also one Peter Young, a European fund manager with Morgan Grenfell who enjoyed a strong following, who fell from grace in a spectacular fashion. It turned out his success was based on trickery and fraud, resulting in his prosecution. But the abiding image for many who followed this story was his arrival in court dressed as a woman. Interestingly, I lunched with one of his ex-colleagues the week the story broke who told me the revelation of his dark doings came as less of a surprise to those who had worked with him than it did to the investors who backed him. One wonders why he wasn’t spotted as a wrong ‘un sooner.

Some stars remain in the firmament. Peter Lynch, who ran the biggest mutual fund in the US for many years – Fidelity’s Magellan Fund, became a legend and published a book which included many quotes I found useful when addressing investors and their advisers at conferences. In “Beating the Street” he opined that no-one could accurately predict the future direction of stock markets, currencies or economies. “Dismiss all such forecasts” he said. Yet he grew the fund significantly over the years and was able to retire at the age of 46, turning his considerable energies to charitable works.

BACK TO THE FUTURE

One cannot help but wonder what the likes of Nick Train and Terry Smith might view as their future legacy. Terry Smith was an investment analyst at James Capel (now HSBC Investment Bank) when I worked there in the 1980s. I knew him, though not well. His book, Accounting for Growth, published in 1992 sent shock waves through the investment industry, but probably gave him the opportunity to prosper in the way he has as it made him hard to employ in the investment banking world and probably encouraged him to establish his fund management business. In 2019 his was the only fund to rank in the top ten of those that attracted positive inflows that was not an index-tracker. It is now one of the biggest retail funds in the UK.

TRAIN OF THOUGHT

When Nick Train and Mike Lindsell set up their fund management business, I met with Nick and was encouraged to back the investment trust they launched at the outset, which is arguably the best investment decision I have ever made. A thoughtful and considerate manager, he would be the first to admit that successful positive runs can come to an end without warning. The problem, of course,

The problem, of course, is that as a star manager, your every decision is under close scrutiny so, when something does not go according to plan, you can expect plenty of media coverage on your apparent mistake

is that as a star manager, your every decision is under close scrutiny so, when something does not go according to plan, you can expect plenty of media coverage on your apparent mistake.

ANY GOLDEN RULES?

There are no truly golden rules that investors and their advisers should follow when trying to decide whether a star manager is worth backing. Obviously, consistency in delivering above average returns is bound to encourage support, though no warning bells ring when the stance they have pinned their strategy to suddenly turns sour. Bill Mott, who I knew for years as a consistent income fund manager, suffered greatly in the wake of the financial crisis of 2007/08 when banks were forced to cut or even eliminate their dividends.

The Neil Woodford debacle highlighted the pressure these high-profile managers are under to deliver superior returns. His comeuppance came as a result of overloading his funds with illiquid investments in an effort to achieve the asset appreciation he knew his investors had come to expect. It might have worked in the long term, but doubtless now the regulator will be looking closely at the nature of investments held in open-ended funds where instant encashment is considered a right. So should advisers.

Brian Tora is a consultant to investment managers, JM Finn.