Born Under A Lucky Star?

“You must never, as a fund manager, stick your head in the sand saying ‘everybody go away, I’m right, I’m right, I’m right’. You’ve always got to expose yourself to criticism and the analysis that you may be wrong.”

Neil Woodford FT 2017

“Remember that rugby is a team game; all 14 of you make sure you pass the ball to Jonah.”

Anonymous email to 1995 All Blacks Rugby squad

For those of you who don’t know, Jonah Lomu was a one-man, wrecking ball rugby player who, when he burst onto the international scene at the 1995 World Cup, singlehandedly demolished opposition defensive lines. He was a star in the truest sense of the word and any team would have killed to have him on their side. Rugby is, however, the epitome of a team game and Lomu was in fact surrounded by fourteen immensely talented players. The fact that only keen rugby fans would be able to tell you any of Lomu’s teammates from that World Cup demonstrates the alluring simplicity of a narrative with a star at its centre. This is as true in the world of fund management as it is in sport, music or film. Yet with the recent failure of certain “stars”, the most notable of whom in the UK has been Neil Woodford, people are questioning the validity of the star fund manager. As our own investors will know, we refute this idea. We still believe that active investing does work, but we put our trust in the perhaps less exciting but more reliable proposal of a solid process, implemented by a responsible and diligent team, rather than the paradox of a rock-star-fund-manager.

For avoidance of doubt, when we talk about star fund managers, we refer to those investors who have consistently outperformed the market, meaning that they are lauded by the media and investors alike. There have been many over the years earning such fame they need only go by their surname: Templeton, Druckenmiller, Lynch, Ackman, Bolton. Indeed, the most famous among them needs only his first: Warren. Their investment vehicles attract vast funds and their observations, comments and interviews are consumed by millions. But even for these stars, performance is not guaranteed, with bouts of underperforming years interspersing the good ones. Even Buffett’s Berkshire Hathaway, which has outperformed the S&P by an annualized 5% over the past 31 years, has underperformed it on an annual basis in nine of these years.

The point is that, even if we acknowledge that there are some legends of the game who deserve their status (which we do), one can’t expect them to provide superior returns every year. Investors shouldn’t therefore blindly trust them to always outperform nor get upset when things go awry.¹ We also note that there are many supposed star managers who are more often than not found out to be just experiencing good luck. Finally, we would argue that the real driver behind a lot of these genuine stars’ success is the process they implement rather than an intangible midas touch.

But there is still a fundamental problem that we have with the idea of an individual running a process alone. Human beings are inherently irrational. We are prone to a multitude of emotional and psychological biases, most of which, when investing, have the two driving furies of greed and fear at their heart. These frequently lead fund managers to make mistakes that can ruin their track record and reputation. No matter how good one’s process is, if you are operating alone, there’s no guarantee that you won’t try to circumvent it.

One of the common traps that supposed stars fall into is when they start to believe their own hype and that everything they touch will turn to gold. Sometimes star managers will fail because their performance is down to luck. Often it is because they stop sticking to their process. This might be because their ‘process’ falls out of vogue and they divert to the next passing trend. Or they might believe they can achieve higher returns by switching to a new strategy. In both cases overconfidence will likely have influenced their decision resulting in what is termed as style drift. Arguably this is one of the central reasons behind Mr. Woodford’s fall from grace.

Without wanting to revisit what countless financial journalists have already commented on, it is a useful cautionary tale. Woodford made his name investing in, primarily, large cap, defensive high quality, stocks, thereby avoiding both the tech crash and outperforming during the GFC. It’s not clear whether this was due to a superior process, or more just due to the styles in which he was invested. Either way we can safely say it wasn’t due to him being able to look into the future. Yet, when he set up his own shop, freed from the shackles of Invesco’s risk management and able to operate with autonomy, he started to invest in a mixture of micro caps, unprofitable, vertiginously valued and, in some cases, unlisted companies. Eventually some of these had spectacular blow ups. Of course there are other factors behind his downfall, and much of the blame could be laid at the feet of platforms and wealth managers who built up the hype and continued to market a product that was demonstrably different to what he had produced before. We should further point out that until 2018, Woodford hadn’t actually lost his investors money, he had just underperformed. It is clear though, that some of his downfall came from this style drift and much of this presumably came from there not being enough dissenting voices around him, despite what he said to the FT in the quotation above.

This is precisely why we insist on having a strong team to back up a strong process. Our philosophy helps us to identify the best companies in which to invest. Our process allows us to pick the best among these and to avoid picking any false prophets. The team ensures that we implement the process properly. Being surrounded by a group of intellectually curious people, incentivised in the right way, often results in being peppered by questions that challenge one’s argument. While this can sometimes be frustrating, it means that no stone is left unturned and that we avoid those emotional and psychological biases. Perhaps even more importantly though, having a team to enforce a process removes key man risk. The investors who lost money in Woodford funds are often mentioned in the press. But what about the investors at Invesco when Woodford left? They were left with an option to either reallocate their money at Woodford or to stay at Invesco with a manager with a different investment approach. A team ensures consistency of approach, immune to the comings and goings that inevitably happen in the working world.

We understand why people might put their trust in certain individuals. What we can’t understand is why people would do so blindly without trying to understand what they are actually doing to drive their performance. Perhaps what those genuine legends of investment have in common is a freakish discipline to stick to a process without temptation, rather than some form of innate ability. It’s more likely that, as with Jonah Lomu, they are supported by a strong team and process around them. An investor takes on far less risk if a fund manager’s process is clear and is enforced by a disciplined team. We would caution investors to look beyond the track record and look at how their holdings have changed over time and to check if they are still investing in the same types of companies, if their turnover has remained consistent and, ultimately, if their process and philosophy makes sense.

Q. Macfarlane,

1 November 2019

¹Arguably this is where some of the histrionics with Woodford are overdone. The level of expectation around his performance had been built up too high.

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