Don’t be blinded by the light of a supernova

Persistently skilled fund managers are a very rare commodity, hard to identify in advance and hard to live with over time. Anecdotes and examples of great managers are often used to justify active management, yet even some of the truly ‘great’ managers have failed to live up to their billing. Like the laws of physics, where many big stars eventually reach their evolutionary end in a supernova, the rules of efficient markets, the zero-sum game where losers must fund winners, investment costs and poor investor behaviour have a similar impact on those labelled as ‘star’ managers.

Bill Miller and Anthony Bolton are examples of stars whose brightness dimmed after having much success early in their careers along with Neil Woodford, anyone who has read the paper lately would know – has suffered a humiliating and potentially, career ending demise. Liquidity problems associated with holding privately held companies in his Woodford Equity Income fund spiralled out of control. He and his business partner are estimated to have taken dividends from the firm of around £100 million leaving investors counting the cost of over 60% losses in their investments.

Investors today are lucky. They can invest in low cost, diversified systematic (disciplined, rules-driven) funds that seek to capture specific risks in the market which are expected to deliver higher returns than the market, such as the premium associated with smaller companies or those of value (less healthy) companies. Identifying the best-in-class funds and living with them over time becomes far easier. It takes away the risk of attaching the success of your investment programme to one or a small handful of stars, who may well become supernovas. Remember that over a 15 year period, around 6 in 10 funds cease to exist.

The key conclusion of this short note is that although there may well be some skilled managers to invest with, they are few and far between, are difficult to identify in advance and very difficult to live with. A real risk exists that you may be wrong, which in cases such as Woodford can have very real financial consequences. In today’s investment space, taking these risks is unnecessary, stressful and the odds of them paying off are low. If you stick to sensible market risks captured by systematic funds, then sensible longer-term returns should follow. Don’t be blinded by the light of a supernova.