Judging the
performance of active fund management when markets are tumbling

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With the vast majority of actively-managed funds seeing heavy losses in the first quarter of 2020, it can be difficult to make an assessment of the relative performance of different fund managers. But new analysis from pension consultants LCP suggests that there are still lessons to be learned from the last few months when selecting active fund managers and active investment strategies.

Unsurprisingly, Q1 2020 was one of the most extreme quarter on record in markets generally, and many strategies had their worst month and quarter ever. But LCP’s analysis suggests that headline fund performance in Q1 may not be a good guide to the underlying quality of an active fund manager. One of the main reasons for this is that markets moved so suddenly, managers had no time for major asset reallocations. As a result, performance at the end of the quarter was largely determined by the mix of investments at the start.

LCP’s Q1 analysis of the key active strategies used by pension funds and private wealth managers found:

  • In multi-asset, some funds that were hedged or defensively positioned going in managed to keep losses low (<5%). However, these were usually the same funds that have lagged in previous years.
  • In Absolute Return bonds (used by pension funds and by private wealth managers in lower risk model portfolios) there was a very wide dispersion of returns. Some managers were found to be carrying more risk than thought. Many ARB funds have not achieved their objectives over a three- or five-year period. LCP finds that similar investment outcomes can be achieved at much lower fees and complexity – e.g. buy and hold short dated high quality bonds.
  • In Multi-Asset Credit there was a lot of variation in returns by manager, and a very substantial rally after the quarter-end, so Q1 needs to be seen in this context. The covid19 crisis has rendered some previously stable sectors as much more vulnerable to defaults, and this has been reflected in prices. Going forward, this is where LCP see the best opportunities for portfolios looking to benefit from a recovery. Sector selection has never been more important.

Rather than simply look at investment performance in recent quarters, LCP believe that the key questions that pension funds, private wealth managers and others should be asking of active fund managers are:

  • Is the process right?

    Is your portfolio consistent with the way you have described your approach? Is there any ‘style drift’ or ‘tourism’, where managers make allocations to areas beyond their skill set in search of returns?

  • Why do we own this: Is there still a good fit with the long-term objectives of investors?

    Investing is about setting long term objectives and getting the best strategies to fulfil them; strategies change over time and new options become available at better fee rates. Investors and allocators should always be checking they have the right strategies for their portfolio at the most competitive fees.

  • Have you had companies default in the portfolio? How would you handle them?

    In credit investing avoiding defaults is a key skill of an active manager. Too many will hamper returns and may cause distraction to the portfolio managers.

  • Are the key people still in place?

    Times of stress and bad performance can lead to personnel changes which fund allocators need stay on top of. It always helps to decide in advance who the key people are at any fund management firm.
  • What has been happening to asset flows on the fund(s)?

    Negative returns will prompt some investors to redeem from a strategy, if a sizeable proportion of investors do this the fund can become hard to manage and the portfolio manager can lose focus on generating returns.

    Commenting, Dan Mikulskis, partner at LCP said: “When markets are volatile it is more important than ever to have the right people managing your investments. Our analysis shows that performance in the first quarter of 2020 was more about the asset mix at the start of the year than about the skill of managers in responding to the crisis. Whilst everyone can be affected by sudden shocks, the best asset managers will stick to their process, and areas of specialism. We advise investors to keep investment costs and strategies under continuous review, in light of their objectives”.