Filtering the market

12 August 2019

By John Husselbee, Co-Fund Manager HC Verbatim Portfolio Growth Funds

When building managed portfolios and looking to diversify by blending funds, one of the key tasks is to make sure you are not simply replicating the market at greater cost.

With so many thousands of funds available, many ultimately do the same things, no matter what they might say, so it is vital to ensure you are combining genuinely different styles to get the full benefits of diversification.

One of the integral parts of our multi-asset process is the view that consistency of performance is all but impossible but consistency of process is a necessity for our underlying managers. Without resorting to usual clichés, we are looking for managers who do what they claim to. Anything that can help us analyse that process in more depth is a useful addition to our toolkit – especially with so much debate around how much value active managers are actually adding over the long term.

Most advisers and investors will likely be aware of Morningstar’s Style Box, launched back in 1992 as a way of analysing funds by style and market cap bias. Later this year, the group is set to add a further five factors to its analysis – which covers more than 70,000 portfolios globally – and this was among the topics discussed at Morningstar’s annual investment conference I attended in Chicago earlier this year.

The rise of passives has brought factor-based investing to the forefront and it is said that over 300 factors have been identified by academics over recent years. There are hundreds of white papers out there talking up the merits of many of these but my guess would be that most are just derivatives of the factors Morningstar has identified, namely the current duo of value and size, plus quality, momentum, yield, volatility and liquidity.

This clearly recognises the need to analyse funds based on more than just their value/growth and large/mid/small cap tilts and reflects changes in the concept of ‘value’ stocks for example. Value no longer simply means the asset-heavy slow-moving businesses of old, and further analysis is required to get to the core of how ‘value’ managers are running money. There can be a world of difference between a deep value contrarian stockpicker and a standard UK equity income fund for example and yet both fall under the very broad umbrella of value.

This kind of broader segmentation can also serve as a more effective screening mechanism, reducing the time it takes to either shortlist or exclude a fund as worthy of deeper analysis. One fund highlighted in Morningstar’s research behind the new system has quality in its name for example but is revealed to score right at the bottom of the quality indicator: a quick and easy way of seeing managers are actually doing what they claim.

Funds in our portfolio fulfil defined roles and any fluctuation away from the stated style would be a much clearer sell signal than short-term performance-related issues – and more detailed style analysis helps show which managers have the courage of their convictions when conditions are against them and which do not.

Keeping faith in a particular style can involve an element of career risk – we saw many value managers dismissed as dinosaurs amid the tech bubble for example – and we continue to have a bias towards those long in the tooth, veteran investors who have been through a few market cycles, whose style is ingrained and will not change however the market behaves.

Within our portfolios, a good example of a couple of such managers the UK equity side are Nick Train, who runs Lindsell Train UK Equity, and Fidelity Special Situations manager Alex Wright.

Train is a classic quality growth manager who rarely adds new stocks to his portfolio while Wright is from the Fidelity contrarian value school, following in the footsteps of long-term Special Situations manager Anthony Bolton.

When analysing Train, we find a manager whose success has clearly been dependent on maintaining a buy and hold discipline, looking to find great brands and then letting them compound over time. His near £6bn UK Equity Fund has just 20 holdings and while such a strategy can be vulnerable to shifts in market sentiment, we are confident Train will never veer from his tried and tested approach.

Similar discipline is clear in Wright’s approach, with the manager looking to find stocks unloved by the rest of the market and therefore trading at discounted valuations. This can mean periods where the fund can lag but over time, if done well, such a philosophy can improve the balance of risk and reward by limiting downside and maximising potential upside. Again, with contrarianism baked into Wright’s philosophy, we are confident the fund will maintain its style bias whatever the market conditions.

If diversification is to work properly, all the underlying components need to maintain their style integrity – and the more accurately we can analyse and monitor that style the better.  

The value of investments and any income from them can go down as well as up and is not guaranteed. Your clients could get back less than they originally invested. Past performance is not a guide to future performance. The portfolios' investments are subject to normal fluctuations and other risks inherent when investing in securities. Verbatim Asset Management has taken due care and attention in preparing this document, which is solely for the use of professional advisers. Verbatim cannot be held responsible for any inaccuracies arising out of information detailed within and will not accept liability for any loss arising out of or in connection with its use. This article is for information only and should not be deemed as advice.