Poor products, reputational damage and the mistaken belief that “bigger is better” are all reasons Seneca Investment Management’s Peter Elston abhors poor active management. 
Elston (pictured), who is chief investment officer at the multi-asset boutique, said the more interesting investment opportunities tend to be out of reach of larger firms.
He said: “I abhor poor active management because there are so many people whose retirement savings have been invested in poor products; because it has given the active management industry a bad name; and because the big firms who are the worst offenders continue to peddle the notion that bigger is better.
“With, for example, football clubs, bigger generally means better quality. This is absolutely not the case with active management; the more interesting investment opportunities tend to be smaller and out of the reach of large firms.”
Elston said he agreed with and adores Gina Miller – the sound partner of SCM Private and transparency campaigner – who said she must act when she believes “people are being bullies, or being dishonest or hypocritical”.
He explained: “Most big fund management companies for me tick all three of those boxes. There’s plenty of evidence that most actively managed funds fail to beat their benchmark net of costs.
“The implication of this – and the associated headlines – is that funds that beat their benchmark have done a good job, and that funds whose performance is in line with the benchmark have achieved what they set out to achieve. This has to be wrong.”
The veteran investor said: “Active managers should aim to beat their benchmark by a wide margin to compensate investors for the risk that they will fail to reach it.
“Why on earth should an investor accept index performance with risk when they could get, from a passive fund, index performance with no risk?
“Most single asset class funds have an investment aim or objective that is vague, and a benchmark which is an index.
He added: “Where there’s a benchmark stated, it’s not generally clear what it’s there for, but let’s assume it is for performance measurement purposes. After all the proper definition of a benchmark is ‘a measuring device’ not ‘something to be copied’.”
The Seneca CIO said active funds should state the margin they aim to beat the benchmark by, net of costs, to show the value added by active management.
“My starting point is to consider the costs for a particular fund, then to aim to produce a multiple of these costs in gross outperformance – alpha,” he explained.
“I make sure that we have sufficient tracking error to give our funds the potential to produce this alpha – too little tracking error is in my view worse than too much – then trust our value-oriented investment style and process to achieve it.”
Elston said it employs a multiple of costs “considerably above two” for each of its three open-ended funds.
The benchmark on its investment trust – Seneca Global Income & Growth Trust – was also recently changed to reflect its views and now aims to achieve a total return of at least CPI inflation plus 6 per cent per annum after costs.
“Benchmark changes are generally met with great scepticism, and rightly so, but in our case we have raised the bar rather than lowered it,” he said.
“The previous benchmark of Libor plus 3 per cent did not reflect how the trust was being managed. The change won’t mean we have to start jumping higher – we won’t change the way we manage the fund.
“The bar has been raised to a level commensurate with our process rather than at an inappropriately low height.”
Performance of trust vs sector & old benchmark over 3yrs
Source: FE Analytics
Over three years, the Seneca Global Income & Growth Trust rose by 44.26 per cent, compared with a 10.89 per cent rise in the old benchmark.
Elston’s comments follow the publication earlier this year of the Financial Conduct Authority’s (FCA) ‘Asset Management Market Study’ final report.
As part of its measures set out in the report, the regulator announced it would be setting out a working group to consider how to make objectives clearer and more useful for investors, including greater clarity over why a benchmark has or hasn’t been used.
“At the individual investor level, industry participants often examine net returns against a benchmark as a measure of value for money,” the FCA highlighted.
“In these cases the benchmark can act as a proxy for the risk element. We recognise that a comparison of net return against a benchmark is not always the most appropriate measure of value for every product, as noted by respondents.”
However, the UK financial services regulator further noted that “on average both actively managed and passively managed funds did not outperform their own benchmarks after fees”.
Yet, for Elston, the focus remains on poor actively-managed funds, adding: “I’d argue that the objectives of most actively-managed funds are not ambitious enough.
“Perhaps this is why the active management industry is so despised. Many, including me, think it is still providing a safe harbour for the cowardly.”