Interactive Investor

When is the best time to catch a falling star manager

23rd April 2015 10:42

Fiona Hamilton from interactive investor

How long should you stay loyal to a formerly successful trust that has seen its performance slump? Conversely, when should you capitalise on a collapse in a trust's rating, in the belief it will regain its former glory?

These questions are relevant to followers of managers such as Bruce Stout of Murray International, Gerald Smith of Monks and Harry Nimmo of Standard Life UK Smaller Companies.

Some might think they also pertain to the likes of Capital Gearing, Personal Assets and Ruffer Investment Company.

Fund manager Baillie Gifford complains that institutional clients are judging their active managers' performance over ever-shorter time periods, and research by consultancy firm Spence Johnson shows UK pension funds now typically give managers just a year to recover from poor performance.

Index-hugging

Baillie Gifford believes this is disastrous, as it encourages index-hugging - which undermines the case for active management - and high turnover, pushing up costs.

Successful active management, as recently epitomised by James Anderson of Scottish Mortgage, usually involves an index-agnostic approach and a long-term view on a limited range of companies.

This can result in occasional steep setbacks, such as SMT suffered in 2008. But those who stayed loyal to the trust have been richly rewarded, as were those who retained faith in Anthony Bolton and Neil Woodford in the late 1990s, when they were well down the league tables.

If a trust's manager has an exceptional long-term record, then investors certainly should not judge them on a one-year lapse. James Henderson, for instance, has an outstanding 20-year record as manager of Lowland.

Its shares have slumped over the last year, because its net asset value (NAV) returns have been unusually disappointing, and its rating has collapsed from an 8% premium to a 5% discount. This looks much more like a buying than a selling opportunity.

Three years of below-average returns, such as MYI has suffered, is more worrying. But investors must dig into the reasons for the setback in order to decide whether to sell, hold or buy.

In MYI's case the disappointment is largely attributable to Stout's aversion to the US as an overvalued market with an inadequate yield, and his preference for the faster long-term growth offered by the Far East and emerging markets.

It is backed by his escalating pessimism about the global economy and therefore by a focus on sizeable companies with strong balance sheets that can deliver solid dividend growth. "Preservation of capital remains key in such a relentlessly hostile environment," Stout declares.

John Newlands, head of investment company research at Brewin Dolphin, is keeping Murray International on his highly selective buy list. "Stout is a great fund manager. His methods will go in and out of style, but in the long run they should come right," Newlands says.

Alan Brierley, director of investment company research at Canaccord Genuity, shares Stout's pessimism about the global outlook and market valuations, and also rates MYI a buy.

Paying too much

Tim Cockerill, investment director at Bristol-based wealth manager Rowan Dartington, says: "Stout has a very good long-term record. If I held Murray International I would not sell, and if I had always fancied it, this is not a bad time to buy."

But Jean Matterson, partner at Rossie House Investment Management, is more nuanced. She says investors are currently prepared to pay too much for income, and the trust's premium rating is being propped up by its 4.3% yield. However, she expects Stout's preference for Asia and Latin America to prove its worth in due course.

Monks has also suffered from too much in emerging markets in recent years, but has shifted its balance over the last year or so and now has 40% in North America. Despite this, its NAV total returns are among the worst in the global growth sector over one, three and five years, and its 10-year returns are also below average.

Its higher US weighting may yet turn out well, but a number of Smith's previous top-down calls have proved badly timed, and his penchant for offbeat share selections appears to have resulted in fewer winners than losers. So investors can be forgiven for quitting, even though Monks' shares are now on a double-digit discount.

Smith's closest colleague, Michael MacPhee, retired from Baillie Gifford in April 2014. MacPhee had managed Mid Wynd investment trust for 15 years, and it had a lot of common holdings with Monks.

On his departure Mid Wynd's board moved the mandate to Artemis, where the trust has performed well. Arguably the Monks board should be considering a similar move, or at least a more dramatic change in personnel than the January 2013 appointment of Tom Walsh as deputy manager.

Monks chairman James Ferguson and director Douglas MacDougall both have massive stakes in Monks, which the latter once managed. Their holdings should align their interests with those of other shareholders; however, as Edinburgh grandees they may be reluctant to knife Smith, who is widely admired at Baillie Gifford.

Monks disappoints

Brierley has included Monks in his model portfolio for some years, but is disappointed that a recovery in 2013 was followed by relapse in 2014. Eyeing the discount, he says: "There is obvious value here for the contrarian investor and if matters don't improve soon, then pressure for decisive action will grow."

Newlands believes Smith will turn the trust around, so long as the board does not undermine him by tinkering too much with his approach. In contrast, Matterson suggests the board should persuade Smith to start investing in less obscure value plays.

She says Walsh has been a positive influence and investors should hang on, as the shares look cheap and should hold up better in a setback than those of more growth-oriented and highly rated trusts such as Scottish Mortgage. Cockerill, however, believes Smith has made too many mistakes, and it "might be time to move on".

Cockerill is a lot more positive about Standard Life UK Smaller Companies, which has the best 10-year returns in the UK smaller company sector, but among the worst over three years. Manager Nimmo deploys a quantitative screening process and Cockerill says this can be badly disrupted by inflexion points, such as occurred last spring. He says Nimmo has recovered strongly from similar setbacks in the past and has not changed his style, so he is confident the trust will recover and rates it a buy.

Matterson prefers Aberforth Smaller Companies and Henderson Smaller Companies, which are both currently on wider discounts. But Newlands joins Cockerill in giving Nimmo the thumbs up.

Capital Gearing, Personal Assets and Ruffer have even worse three-year returns than Monks and Murray International. However, they do not deserve the same criticism, as all three make it clear their top priority is wealth preservation and they are therefore not too worried about lagging in a bull market, so long as they hold up well in downturns.

The sustained bull market means all three now lag the FTSE All-Share index in terms of NAV total return over five years, and only Ruffer - which tries to keep a balance of positive and defensive holdings - is ahead of the All-Share index over 10 years.

Nonetheless, Capital Gearing has achieved positive net asset value returns in all but one financial year since Peter Spiller took charge in 1982.

Capital Gearing shareholders have fared less well if they failed to sell, or worse still bought in July 2014, when the premium on the shares touched 17%.

But, with the board committed to minimising any discount, there is little extra downside now the premium is almost eliminated, and Peter Spiller expects his current positioning to allow him to make a lot of money after stock markets collapse from current levels.

"Stockmarkets will be no higher than they are now in 10 years," he predicts, "but they will have fallen back sharply in the meantime."

Matterson has a lot of confidence in Spiller, but preferred his open-ended vehicles when CGT was at a large premium. She is not worried if Personal Assets lags in rising markets, as it is "a get rich slowly vehicle". She says Ruffer takes punchier bets, and has been less reliable since Jonathan Ruffer retired as lead manager in 2012, but that it has similarly fulfilled its role as absolute return vehicle.

Newlands says: "Ruffer, like Personal Assets, has been braced for the world to come to an end, and it hasn't. Their day might come, but current market conditions do not suit them. However, Ruffer remains on our buy list for high net worth individuals who want the comfort of positive market returns under almost any market conditions and low volatility."

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.