Investors cannot rely on multi-managers whose only strength is getting the major asset-allocation decisions right, according to BMO Global Asset Management’s Scott Spencer (pictured), who says it means “diddly squat” if they don’t pick the right funds
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Spencer, an investment manager on BMO’s multi-manager team, pointed out that there was an average difference of 20 to 30 percentage points between the best and worst performing funds in each IA equity sector in 2018, while even in the fixed income sectors there was an average difference of 5 to 10 percentage points.
“So it is vital that you get your fund selection right,” he said. “To give you a real-world example, anyone who follows Donald Trump and his tweets will know that the US clearly felt that it had won the trade war, based on stock market performance – the average IA North America fund was down 1.37 per cent last year, while the average IA Asia ex Japan fund was down 9.81 per cent.
“However, if you had bought funds we own like Prusik Asian Equity Income, that was only down 79 basis points.
“We actually had a fund in our BMO MM Navigator Distribution fund called CIM Dividend Income which is an Asian income fund which was up 6 per cent last year. So, if you get the fund selection right, you can offset getting the asset allocation wrong. And we were underweight the US and overweight Asia.”
Spencer said this is not just about getting the right manager either, pointing out the best-performing fund in the IA Asia Pacific ex Japan sector in 2018 was Newton Asian Income, which made gains of 0.21 per cent compared with an average loss of 9.81 per cent for the sector.
What is interesting about this, however, is that the same management team behind this fund, Newton’s emerging and Asian equity team, was also responsible for the second-worst performer in the sector last year – Newton Oriental, which lost 19.51 per cent.
Performance of funds vs sector in 2018
Source: FE Analytics
A spokesperson from Newton said the Oriental fund’s underperformance last year was partly down to stock-specific issues and partly down to “the extreme factor rotation”.
“The market swung in favour of dividend yield stocks and value stocks at the expense of high quality, high-return-on-capital companies and long-term growth stocks,” they added.
“This rotation meant that many of the high-quality stocks we own suffered de-ratings in excess of any earnings downgrades.
“Newton Asian Income was much better suited to the environment described above from a style and characteristic perspective.”
Spencer said this highlights the fact that last year quality in income was clearly the way to go across multiple sectors.
“If you had a quality bias driven by either income factors or just underlying fundamentals, you really dominated,” he added.
“This wasn’t just the case with Asia, but it was the case with the US, Europe and Japan, all the quality funds outperformed, they were at the top-end of the charts. What was at the bottom-end of the charts was the value funds.”
One of the few exceptions to this rule from a regional point of view was the UK, where value did slightly better. For example, the two best performers in the IA UK Equity Income sector were the value-focused Schroder Income and Income Maximiser funds – the second of which is the largest holding in BMO MM Navigator Distribution – which fell 0.96 per cent and 1.81 per cent respectively, compared with losses of 10.54 per cent from the sector average.
However, Spencer pointed out that just because a quality bias outperformed in most sectors in 2018, it doesn’t mean it will work again this year.
“You only have to look at the bond market,” he continued. “Last year across all the bond sectors, what dominated returns were funds with ‘short’ in the title, if you were short duration, you were at the top-end, if you were long duration, you were at the bottom-end. And a great example of this would be looking at the IA Sterling Corporate Bond sector, where nine out of the top-10 funds in that sector all had short in their title.”
“The reason I mention that, if we go back to the previous year, 2017, nine of these funds – so all bar one which hadn’t actually launched yet – were in the bottom quartile. It just shows you what a difference a year can make to funds. And we are at the moment slowly positioning more towards value as we enter this period of change. Value is going to be working. Just because it hasn’t worked in previous years, it doesn’t mean it can’t work.”
Spencer said the best example of where fund selection proved more important than getting the sector calls right in 2018 was in IA Targeted Absolute Return.
Rising volatility in markets should in theory play into the hands of the sector – which aims to deliver positive returns in all market conditions – however, the average fund in the sector was down 2.81 per cent last year with just 17 of 118 funds making a positive return.
“You could have lost money and still outperformed the sector average,” he added. “So, lots of people are moving towards that sector, but again, if you don’t get your fund selection right, it doesn’t really mean anything.”
Data from FE Analytics shows BMO MM Navigator Distribution has made 98.93 per cent over the past 10 years, compared with 81.51 per cent from its IA Mixed Investment 10-60% Shares sector.
Performance of fund vs sector over 10yrs
Source: FE Analytics