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If fund managers aren't paid right, forget it

Lee Gardhouse and Roger Clark of Hargreaves Lansdown explain why they won't invest in a fund if the manager running it isn't incentivised properly.

 

by Chris Marshall on Jul 10, 2013 at 09:46

If fund managers aren't paid right, forget it

How to pick an investment fund: make your selection based on the fund manager, rather than the fund itself. And if they’re not incentivised properly to do their job well, don’t go near them.

That, in a nutshell, is the philosophy espoused by Hargreaves Lansdown ‘multi-managers’ Lee Gardhouse and Roger Clark, who run funds that invest in other funds.

Two strong trends in their HL Multi-Manager Special Situations Trust (a unit trust rather than investment trust) prove their adherence to this system: an inclination to invest in funds provided by small, ‘boutique’ investment management companies often at least partly owned by the fund managers and a large exposure to the UK (39%). 

‘We’re manager-focused rather than taking a particular asset allocation view. The UK weighting reflects the number of exceptional managers in that market,’ says Clark, in an interview with Citywire. Neil Woodford’s Invesco Perpetual High Income fund and Majedie UK Equity count among the fund’s top UK holdings.

They recognise too that the UK market comprises companies facing outwards into faster-growing parts of the world.

‘The starting point is the fund manager rather than fund. We think it’s the person pulling the trigger that is most important,’ he adds, explaining that the region targeted by the fund is secondary to fund manager choice too.

By that logic, did they invest in Anthony Bolton’s unsuccessful Fidelity China fund after the fund manager’s tremendous performance investing in the UK? No, ‘that would have been a leap too far’.

The pair first crunch the numbers using a tool they have developed with colleagues at Bristol-based Hargreaves Lansdown, the popular fund supermarket and stockbroker that also runs some of its own funds. ‘That allows us to whittle down choices to value adding managers’, says Clark. They then meet fund managers to ‘understand their philosophy, their temperament, how they’re incentivized’.

Gardhouse (pictured) expands on the importance of fund manager incentivisation. ‘We’re trying to invest with fund management groups where there is a direct relationship between the manager doing well and being rewarded…a share of profits, or they have to hit specific targets’.

An extreme example is the GLG Japan CoreAlpha – an 8% holding in the HL Multi-Manager Special Situations Trust – whose managers are paid entirely according to their performance.

Many funds don’t make the cut, normally those run by large asset managers. ‘Lots of companies’ set-ups aren’t conducive to good performance because the incentives aren’t there,’ says Gardhouse. ‘There are tens of [asset management] groups where we’re never going to buy any funds because we don’t believe they are set up to do a good job for investors.

‘They tend to be asset gathering rather than delivering decent performance.’

In addition to better incentivisation structures, funds run by boutiques ‘normally have free reign, are not index restrained’, he adds.

Examples include the Findlay Park American fund , and Traditional Funds Eastern Europe , both top holdings in HL Multi-Manager Special Situations Trust.

The latter fund’s weak performance so far this year doesn’t faze Gardhouse and Clark who have held the fund since launch and say their money has been multiplied by seven during that time.  

Fund manager Martin Taylor is reason enough to hold on. ‘We wouldn’t have that much in east Europe if weren’t for him,’ they say.

The Hargreaves pair count Taylor alongside the teams running the Marlbrorough UK Micro Cap Growth and Old Mutual UK funds (they hold both the Old Mutual UK Select Smaller Companies and UK Dynamic Equity fund ) as the best in the business.

After all, says Clark, ‘it’s the person pulling the trigger that’s most important’.

The HL Multi-Manager Special Situations Trust has returned 45% over three years, making it the best performing multi-manager fund in the global equities fund sector, according to Citywire data.

23 comments so far. Why not have your say?

sgjhaghsdg

Jul 10, 2013 at 09:34

Yes, all you need is more managers, layers and layer of them.

Or google for "buffett gotrocks" to see an alternative view.

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Keith Cobby

Jul 10, 2013 at 09:42

The simple answer is to know how much of their personal wealth is invested in their fund.

I always vote against the election of directors in the investment trusts/companies I own if they do not own shares.

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Chris Marshall (Citywire)

Jul 10, 2013 at 09:56

Hi Keith

I asked them about the importance of managers investing in their own funds, but they (perhaps surprisingly) said they didn't think it made any difference. Said some managers don't invest in their own funds as they think they already have enough of their fortunes tied up in fund performance (ie job security etc) that its not warranted.

Plus, Gardhouse said he invests in his own funds and he doesn't think it makes any difference whatsoever to his performance.

Chris

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Keith Cobby

Jul 10, 2013 at 11:21

Chris

Interesting feature, investment trusts/companies is my own area of interest as a private investor and I know that the subject of performance fees is always of concern. Having a holding in his China Trust hasn't helped Mr Bolton, but as with directors I like them to have some 'skin' in the game'. It would be a worthy subject for more research. My hunch is that there would be some correlation.

Regards,

Keith

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Webby

Jul 10, 2013 at 12:11

If you look at the 5-year performance graph for this multi-manager fund on HL's website and overlay the performance of the FTSE Allshare index (make sure you select "total return") then you will see the two traces are almost identical. The only difference being the approx 2% fee you pay for the multi-fund, when you could be paying 0.3% for a cheap tracker.

It's not surprising since this fund of funds must be split among hundreds of companies - you are bound to revert to the market average over time.

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Steve P

Jul 10, 2013 at 14:39

This is simply biased "advice" from vested-interests; read Warren Buffet's story of the Gotrocks family, as suggested before.

The "proper incentivisation" is what actually impairs the performance of managed funds and why the majority of managed funds fail to outperform the index and thus a simple tracker fund.

As John Bogle says, in fact "you get what you don't pay for". Buying one of his books (or one written by Burton Malkiel) instead of the search for the holy grail of the next hot fund manager could well be the best investment you ever make.

BTW, they say investing in Anthony Bolton's China fund "would have would have been a leap too far". I thought HL promoted this fund quite heavily when it was launched...?

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Clive B

Jul 10, 2013 at 15:23

Odd that Buffet is quoted as an example. Surely, he's the same - a money manager who sits between investors and the firms they invest in. Whilst Buffet may take (big) stakes in companies, he doesn't run them himself.

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Not all ETF's are the same

Jul 10, 2013 at 15:24

I assume Lee Guardhouse is adequately rewarded at Hargreaves Lansdown!

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Patrick Neylan

Jul 10, 2013 at 15:39

Amazing that fund managers are still perpetuating this self-serving fiction. All the academic studies going back decades have shown that financial incentives only work for the most menial jobs involving little or no intelligence. For highly cognitive tasks, financial incentives actually impair performance.

Nobel prize-winner Daniel Kahneman demonstrated that, over time, the performance of professional fund managers and stock-pickers is 0.01% better than "a chimp throwing a dart". The manager who did well last year will do less well this year, for exactly the same reason that someone who rolled a six last time will probably roll a lower number this time.

I've got over £50,000 invested with H-L. Maybe it's time I reconsidered. If it's Gardhouse (rather than the journalist) who doesn't know the difference between 'reign' and 'rein', then I'm definitely moving my money.

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Clive B

Jul 10, 2013 at 15:48

@ Patrick

Kahneman wasn't exactly impressed with individual investors either

“It is clear that for the large majority of individual investors, taking a shower and doing nothing would have been a better policy than implementing the ideas that came to their minds….Many individual investors lose consistently by trading, an achievement that a dart-throwing chimp could not match.”

http://investingcaffeine.com/2012/07/08/experts-vs-dart-throwing-chimps/

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Steve P

Jul 10, 2013 at 15:53

@ Clive B:

Warren Buffet runs the company himself and is therefore able to keep expenses low, which he knows is important.

As the CEO of his own company rather than a fund manager, he is not subject to short-termist pressure to invest in certain shares/sectors (i.e. the latest hot stock/sector that will outperform the overall index) in an attempt to outperform the others briefly, and he does not have to post results regularly in the same way as funds and he does not appear in league tables as fund managers do. If investors don't like Warren Buffet's investment strategy, they can sell their shares. If investors do not like a fund manager, the fund manager is replaced.

He is thus not compared to his peers in the same way as most fund managers. This means he can take a genuine long-term low-cost buy and hold approach.

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Robin Lewis

Jul 10, 2013 at 16:06

What nonsense. "Monkey with a pin", a free book on Amazon e-kindle, shows how most fund managers are out-performed by a monkey without an incentive.

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ALANR

Jul 10, 2013 at 16:08

What a load of crap. The same bullshit is used to fuel M.Ps rip off salaries. If anyone needs an incentive to perform it's the swathe of workers on less than £20k per ann not these prasites.

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martin cragg

Jul 10, 2013 at 16:33

Well said Webby! He hits the nail on the head. Gardhouse and Clark are talking a load of self perpetuating crap. Anyone who invests in a fund of funds needs their head examining.

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Clive B

Jul 10, 2013 at 16:54

I doubt that the average private investors do any better than the average fund manager, even allowing for fees.

Websites like this are full of people saying "I invested £x in shares in company A and it's gone up by 10%, 20%, 30%", implying a) they're so smart, b) it's so easy (to outperform a fund manager). Problem is that it's only those who do well who write up their investments, you almost never see people saying they invested in shares and lost 10%, 20%, 30%.

Difference is that all fund managers have to publish their results.

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Steve P

Jul 10, 2013 at 17:08

"I doubt that the average private investors do any better than the average fund manager, even allowing for fees."

- I agree, which is why most people would be best off in a tracker fund.

"it's so easy (to outperform a fund manager)"

- It is actually. You can outperform the vast majority of them in the short/mid term and all of them in the long term with a low-cost tracker fund.

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Anthony O' Grady

Jul 10, 2013 at 17:31

Agree that funds of funds are too expensive. Also agree that HL do spout a lot of rubbish. Their SIPP service is excellent, but I would never pay attention to any investment advice dispensed by them.

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Dennis .

Jul 10, 2013 at 21:14

Try looking at Terry Smith's Fundsmith website and his videos, his philosphy is very different to most and more like a Warren Buffet .

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jon smith

Jul 11, 2013 at 10:14

im struggling with the incentive model which at senior management/exec level is no more than 'can write name' or 'knows own address'! its the emperors new clothes syndrome-we need to get back to doing what you get paid for ie working hard--if you can do more then you aint doin what you get paid for!!!

cant remember the last time i won at the bookies and they gave me a bonus!(apart from mug speciality bets)

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Anthony Palmer

Jul 13, 2013 at 11:25

Lets say greed and be done with it, the world, the city, is rotten with it. Thank heaven NHS Surgeons are not so tainted.

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Anonymous 1 needed this 'off the record'

Jul 13, 2013 at 13:25

That's a bit naive. I have met a few greedy surgeons who do the minimum hours a week for the NHS and then as much private work as they can get on the side driven by long NHS waiting times. And who pays for their training?

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matt martin

Jul 29, 2013 at 15:57

Patric - you comment on 10/07: "The manager who did well last year will do less well this year, for exactly the same reason that someone who rolled a six last time will probably roll a lower number this time". You obviously don't understand probability.

It doesn't matter if you throw 3 sixes in a row - there is always a 1 in 6 chance of you throwing a 6 on the next dice, and the next, and the next, forever. That's the nature of probability: these are called discrete events and they are all independent of each other.

By contrast, a the decisions a fund manager makes are not independent events. They are connected by his/her knowledge of past decisions, the history of the fund, expectations of future events, the direction of economic trends and above the psychology of crowd behaviour.

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sgjhaghsdg

Jul 29, 2013 at 17:51

However, history has shown that funds show strong reversion to mean and yesterday's "star manager" is likely to be tomorrow's flop.

The strategy that has been shown to work best is to turn your back on the whole sorry bunch, refuse to allow your money to be used to buy their next yacht, and invest via low cost trackers.

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  • Majedie UK Equity A Acc
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