Good fund managers are harder to choose than good shares, Nic Andrew, the head of Nedgroup Investments, says.
There are, however, a few things you can look for in a manager that will increase your chances of selecting a good one, he says.
At a recent presentation to a Financial Planning Institute investment workshop, Andrew listed the characteristics that distinguish managers who are more likely to out-perform over the long term:
A good manager will be transparent, answering all your questions and telling it like it is.
There should be no investment black box that you don't understand, Andrew says. If you have any doubts about a fund or portfolio manager, you should avoid them, he says.
A good fund management house will either be managed by its owner or the key players will have invested their own money in the same funds or portfolios offered to you.
Andrew says research into the performance of United States-based asset managers conducted by John Bogle of Vanguard, who started the first index fund in the US, has shown that smaller private com-panies tend to perform better than asset managers that are part of large conglomerates.
Fund managers who are likely to be at the top of their game tend to be passionate about investments, hungry for analysis and intellectually curious, Andrew says.
"They eat, sleep and dream investment but are also widely read," he says.
Successful fund managers have the flexibility to close their funds or businesses when they get too big, because they know the size of assets under management can affect performance, Andrew says.
This is particularly relevant in South Africa, where the number of shares on the local stock market is limited and the number of tradeable shares is even smaller, he says.
As the size of a manager's assets under management increases, a manager will be forced either to pick stocks that are not as good or to buy larger stakes in existing holdings.
A manager can have difficulty getting out of larger stakes quickly.
To choose a top manager, Andrew says, you must look at the manager's long-term track record through full market cycles.
Beware, he says, of managers who abandon a particular investment philosophy when it is not performing well - often a new head of investment is brought in to do this. New investment tactics may be adopted at exactly the wrong time in the cycle of the market, resulting in the manager's returns staying poor for longer.
Andrew says you should understand a manager's strengths and weaknesses. You will then better be able to deal with the periods of inevitable under-performance that will occur from time to time.
Top-performing managers also tend to manage risk better by investing in securities that have a high margin of safety. These managers seek out shares that are priced at levels lower than the value that their research indicates the share should be.
He says that by not buying overvalued and popular shares, permanent losses of capital can be avoided.
Temporary losses of capital will occur from time to time when fear among investors sees them dumping shares and driving prices below fair value, but eventually rationality will return to the market and these temporary losses will be recovered, Andrew says.
By protecting your investment from downside risk in this way, a fund manager will earn more consistent returns and the compounding effect of this will give you, the investor, a better long-term result, Andrew says. This is borne out by research conducted by Nedgroup Investments: an analysis of exceptional managers shows that the bulk of their out-performance is attributable to losing less when markets move lower and not during bull markets, he says.
It is more important for a manager to have the right temperament for investing than a high IQ, he says.
The right temperament is one that allows a good manager to think differently and not be influenced by the crowd, he says.
Having the ability to think differently also means the manager can withstand the stress of under- performing and stick to an investment philosophy.
A study of £ large-cap equity managers in the US whose annual returns over the 10-year period ending in December last year put them among the top 25 percent of managers in that category showed that during that period 97 percent of them had at least one three-year period when their returns put them among the bottom 50 percent, and 77 percent of them had at least one three-year period during which their returns put them among the bottom 25 percent of managers (see graph).
Good managers tend to have a high level of conviction and this is usually reflected in a low number of stocks in their portfolios - they take bigger bets on fewer shares, he says.
While they are independent, often contrarian thinkers, they can also change their views if the evidence changes, he says. Resilience, not stubbornness, is what you should look for in a manager.
The fund managers who out-perform their peers typically have key individuals who make the investment calls. They have superior skills in a particular area and are honest about their circle of competence, Andrew says. Managers who make investment decisions in large committees tend to invest with less conviction and less success than those who have key individuals. Managing funds through a democratic process is likely to produce diluted results, he says.
Top managers tend to be bottom-up stock pickers who know their shares well and don't overly rely on unreliable forecasts about the economy, the currency or interest rates to make investment calls.
The fund managers who deliver the best returns tend to have a long-term focus and do not speculate, Andrew says.
They realise that trying to make money over the short term will result in expensive trading and instead have low turnovers in their portfolios, he says. They understand the need to have patience and to wait for the value of a share or other security to be unlocked. Doing less often results in earning more.
Managers who are worthy of your investments launch and manage only a few funds, Andrew says.
They do not launch funds that target the latest fad and do not focus on short-term returns when they market their funds.
Andrew says managers who are stewards of their funds are the opposite of salesmen, who are simply selling products. Performance, not profits, is what ultimately drives the top managers.
It is sometimes difficult to find a manager with all of these characteristics and there are certainly exceptions, Andrew says. But using these guidelines to help you determine a suitable manager will more likely than not result in your picking a successful one, he says.
Allan Gray has again taken the top position in the PlexCrown Ratings management company survey for periods up to the end of September this year.
The manager qualified for inclusion in the survey at the beginning of last year, and it has been the leading manager in six out of the past seven quarters.
The management company rankings are calculated from averages of the PlexCrown Ratings awarded to each qualifying fund that a manager manages.
The PlexCrowns measure the performance of a fund on four different risk-adjusted measures over periods up to five years.
The highest PlexCrown Rating is five PlexCrowns.
Allan Gray has six funds that are rated in the survey. It achieved five PlexCrowns for five of these funds, including its two domestic asset allocation funds, its two foreign funds and its bond fund. The sixth fund, its domestic equity general fund, achieved four PlexCrowns.
Prudential remained in second position in the management company rankings, with an overall average score of 3.792, and Nedgroup Investments was third, with an overall rating of 3.750 PlexCrowns.
Protecting investors against market losses while participating in most of the upside has paid off during the recent volatility for the fund that is the top performer over both the one-year and the three-year periods to the end of September.
The Cadiz Equity Ladder Fund returned 31.76 percent over one year and 20.83 percent a year over three years (according to ProfileData).
The fund is a protected equity fund that uses derivatives to protect it against market losses. It is classified as a domestic asset allocation fund in the targeted absolute and real return sub-category, but it is fully invested in local equities and derivatives.
Francois Finlay, the fund manager of the Cadiz Equity Ladder Fund, says the fund targets an effective market exposure of 75 percent of the portfolio. "What this effective market exposure means is that if the market were to fall by 10 percent, we would expect the fund to fall by 7.5 percent. When we are negative on the market, as we were in April/May of last year, we will reduce this effective market exposure to as low as 50 percent by putting in place derivative strategies that increase the fund's downside protection. When positive, we will increase the effective market exposure to as high as 90 percent."
Evan Jones, Cadiz Wealth's managing director, says the fund does particularly well in volatile times such as those that have prevailed recently and that are likely to continue.
Jones says Cadiz's house style is relative value and it has always focused on managing the risks of investment.
A fund such as the Equity Ladder Fund provides an alternative for investors who are worried about sustaining large losses in volatile markets and often opt out of equity markets at times such as these. However, investing in cash when markets are uncertain means you miss out on rallies such as the one the JSE experienced recently, Jones says.