Some fund managers stick to their knitting irrespective of the wider macroeconomic backdrop; others have more flexibility to change their strategy to respond to market conditions. But which approach is best?
Are investors better sticking with funds that adopt a long-term buy and hold strategy or does the topsy-turvy nature of markets favour those with a flexible mandate to go where the best returns can be found?
Let’s examine this by looking at the pros and cons of each approach and some of the managers who fall into each camp.
Fund managers tend to have a clearly defined investment approach that they adhere to in a variety of market conditions. Investment mandates have varying degrees of flexibility within them, however, which leads to different levels of portfolio turnover.
Having high conviction in a particular investment style can lead to low turnover. For example, Fundsmith Equity invests globally in quality growth stocks unconstrained by benchmark, geography and sector. Manager Terry Smith selects a small number of these, which he holds for the very long term.
Last year, the portfolio turnover was 7.4%, slightly higher than a usual figure of sub-5%, but with a portfolio of only 27 stocks that would equate to buying and selling only two stocks based on an average-sized position.
Other strategies that buy high-quality companies with strong brands and powerful market positions include those in the Lindsell Train stable: Lindsell Train Investment Trust (LSE:LTI), a global investment trust, LF Lindsell Train UK Equity fund, an open-ended fund, and Finsbury Growth & Income (LSE:FGT), a UK equity income investment trust, all run by Nick Train.
“Nick Train is one of the most extreme in terms of low turnover and may go years without adding completely new positions,” says Numis analyst Gavin Trodd.
Another good example of a trust with a very well-defined focus on long-term growth is Scottish Mortgage (LSE:SMT) in the Baillie Gifford stable. Its approach also leads to low turnover, although over the years the way in which this is expressed has changed.
“In the 2000s, it had significant exposure to emerging markets, in the 2010s, internet platforms (Amazon (NASDAQ:AMZN), Google) and technology (Apple (NASDAQ:AAPL)) were large drivers of returns, and the increasing influence of China was a key presence in the portfolio through exposure to Tencent (SEHK:700), Baidu (NASDAQ:BIDU) and Alibaba (NYSE:BABA),” says Trodd. “Now, key themes are the digitalised world, technology meets healthcare and decarbonisation.”
Other strategies have a distinct value style. Among open-ended funds Morningstar highlights the Dodge & Cox Worldwide US Stock fund, which invests in mostly large-cap US equities that look cheap on a range of valuation measures. And in the investment trust world, Peel Hunt analyst Anthony Leatham rates Aberforth Smaller Companies (LSE:ASL) as ‘one of the few standout value managers’ in UK small-caps.
UK equity income trusts often have a value bias as their income objective leads them to value-oriented sectors such as energy and financials. In running Temple Bar (LSE:TMPL), Nick Purves and Ian Lance of Redwheel own companies they believe are trading below their intrinsic value, while Job Curtis at City of London (LSE:CTY) investment trust has shown a tendency for contrarian ideas over the near 32 years he has run it.
“Curtis has kept this approach for his entire tenure, but his experience must help in terms of sticking to his nerve,” says William Heathcoat Amory, head of investment trust research at Kepler Partners.
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Buying and holding stocks for many years allows investors to benefit from the compounding of returns, but patience is often required. Growth stocks were firmly in favour for almost a decade before value staged a comeback in 2021.
A clear style bias in an investment philosophy can also make a strategy easier to evaluate and blend with other funds in an overall portfolio.
“We expect the funds we invest into to remain true to themselves – to ‘stick to their knitting’ – so that we can be flexible when needed and adapt our portfolios, safe in the knowledge that the qualities of the underlying funds will not change,” says Samantha Dovey, head of fund research at Ravenscroft.
Given the number of variables that need to be considered when investing, there is merit in using an unconstrained fund manager – someone who has flexibility to shift the balance of exposure between styles and themes based on prevailing market conditions.
Examples of global investment trusts with more flexible mandates include Bankers (LSE:BNKR) and Edinburgh (LSE:EDIN). Bankers adjusts the style exposure by allocating capital across different Janus Henderson strategies. Edinburgh has exposure to companies with growth, value and recovery characteristics. It has benefited from shifting exposure at opportune moments, with Trodd giving the example of adding to cyclical names following the Covid-19 vaccine announcement in 2020.
In UK equity income, JPMorgan Claverhouse (LSE:JCH) holds a mix of quality, value, momentum and growth stocks. “Since the invasion of Ukraine, the managers have demonstrated their active approach, positioning more defensively by increasing exposure to oil majors and selling out of growth-ier names,” says Trodd.
Pacific Horizon (LSE:PHI) employs Baillie Gifford’s long-term growth approach but has exposure to some usual areas for a growth portfolio. It significantly increased exposure to materials stocks to take advantage of depressed valuations during the pandemic and subsequently sold to take profits.
For funds, Dzmitry Lipski, head of funds research at interactive investor, highlights Artemis SmartGARP Global Equity for its adoption of both growth and value characteristics or ‘growth at a reasonable price’. It is a member of interactive investor’s Super 60 investment ideas.
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Ruli Viljoen, head of manager selection at Morningstar, flags Schroder European for its pragmatic and flexible approach to investing in companies that are cheap relative to their own history. “The portfolio has the scope to move towards areas of relative value whether they be in value or growth stocks,” she says.
In theory, flexible funds should do well in all market conditions, but that depends on managers making the right calls.
“It’s very hard to consistently time markets correctly, which is what funds that change investment style aim to do,” says Shore Financial Planning director Ben Yearsley.
He adds: “They want to ride the growth train before switching to the value bike. To that end you would have to go to growth for about decade until December 2021 then quickly pivoted to oil, gas and financials. How many funds really did this? I’d hazard a guess at none.”
Another downside with flexible funds is that they make assessing exposures and predicting performance more challenging. This is even more problematic when several are blended.
Leatham points out: “Whether intended or not, investors can sometimes experience style concentration risk, and the ability to accurately assess and aggregate style exposures can help to mitigate the negative impact on relative returns.”
What about performance? It seems neither strategy has the upper hand. “There are plenty of examples where funds have been successful following both high turnover and buy and hold approaches,” says QuotedData analyst Andrew Courtney.
His analysis shows there is no significant relationship between average turnover and average return over the past decade, although he concedes that it is unlikely that a single factor would prove significant over such a diverse dataset. He adds: “There are likely to be a range of factors contributing to performance including style and sector biases.”
The best approach for each investor depends on individual objectives and even personality type.
James Godrich, a fund manager at wealth firm JM Finn, points out that for investors trying to manage volatility over the short term, changing style is arguably more appropriate, whereas with a long horizon a buy and hold strategy may be better suited.
He adds: “Someone who is susceptible to herding bias may feel more comfortable with changing style, while someone whose mind may more naturally anchor itself to an existing opinion may prefer to invest in a buy and hold strategy.”
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Thinking about your own personal objectives and preferences is imperative in building a portfolio but so too is diversification. Lipski notes: “You cannot control the risk the fund manager takes, but you can control risk and limit losses within your portfolio by being diversified.”
Yearsley prefers to invest in the best managers in each style – LF Blue Whale Growth for growth, Temple Bar for value, Finsbury Growth & Income for its quality bias and First Sentier Global Listed Infrastructure as a defensive play.
He concludes: “That way you know what you own and can decide on the proportion in each. I tend to have slightly more in the growth style when investing for the long term.”
These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. 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.
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