The outperforming funds flying under the radar

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Many top funds deliver their best returns in the early years, when the portfolio is small and the investment team is hungry for success. But spotting these names before the crowd is easier said than done if you’re a DIY investor.

The latest episode of our On The Money podcast looks at what tools you can use, what you should look for in a fund, and some of the names that have stood out in the past.

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Dave Baxter, senior fund content specialist at interactive investor:Really amazing fund managers are few and far between, and often they can end up enjoying their best performance in some of their early years when they’re relatively unknown. That means it’s really exciting and incredibly rewarding if you can find some of those hidden gem funds before the crowds.

Unfortunately, as we’ll discuss with the tools available to DIY investors, that can be easier said than done. That’s what we’ll be discussing today.

So, welcome back to the On The Money podcast, the show where we discuss the issues affecting your savings and investments. I’m Dave Baxter, the senior fund content specialist here at ii, and today, I’m joined by Simon Evan-Cook, who runs the Downing Fox multi-asset funds.

Simon Evan-Cook, fund manager running the Downing Fox multi-asset funds: Dave, lovely to be here.

Dave Baxter: Thanks for coming on. So, I don’t want to make you feel old, but you’ve been professionally picking funds for 20 years now, is it?

Simon Evan-Cook: Yeah. It’s not you making me feel old, that’s just age. Yeah, I have been in the industry, so working for 30 years and professionally picking funds for 20 of those. So, I’ve been around the block a couple of times by now.

Dave Baxter: And you and your role must pride yourself on finding some of these newer, lesser-known funds?

Simon Evan-Cook: Yeah. Particularly, we do. A lot of fund selectors do that, but it’s almost the heart of what we do at Downing Fox. There’s a lot of reasons for that, and one is that, actually, finding a fund when it is young, so when the fund manager is a little bit younger, not super-young, we’re not hiring 15-year-olds or anything, but when they’re a little bit younger and when the fund is smaller, when they’ve got something to prove, that tends to be, I think, the sweet spot.

So, yeah, we absolutely focus on that because quite often when you find some of these bigger funds that are better known, well known, maybe the fund’s got too big or maybe that fund manager has already made enough money and so they’ve taken their eye off the ball a little bit. So, it’s absolutely at the heart of what we do.

Dave Baxter: Yeah, and I guess they can have distractions like having to market the fund more and grant more interviews and all that kind of stuff.

Simon Evan-Cook: Yeah, more clients. There’s so many different reasons why you would want to find, I think, a fund manager earlier on in their journey rather than later on. We could do a whole podcast on that separately but, obviously, that’s not necessarily what we’re here for today.

But suffice it to say, one of the all-time greats in the US was a guy called Peter Lynch. If you Google him and you look him up, you’ll see a kind of grey-haired old man. I think that’s how people think of this investment legend, Peter Lynch.

But what a lot of people don’t know is that he actually retired at 48. So, he retired when he was younger than I was, and he had, I’d say, about a 20-year career in which he made incredible returns. But he was done and dusted by 48, and most people would imagine you’d want maybe a 55 or 60-year-old fund manager, all of that wisdom. But quite often, it’s not the case.

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Dave Baxter: So, let’s get to what we look at when we’re trying to identify these stars. You and I have the privilege of access to fund managers. We have some amazing tools and data that can inform us about what’s going on in the fund universe. But we’re looking at what retail investors - or to be less jargon-heavy - DIY investors can do on this front.

It’d be good to start off with what sources of information are available to these investors, who have perhaps not as many resources as you and I.

Simon Evan-Cook: Well, the good news is that I think it’s getting better. The bad news is that we’re a long way off where I would think is actually sufficient and good. So, if you were trying to do that maybe 10, 15 years ago, you’d have had the classics, the factsheet, maybe you’d have had an annual report. Maybe you might have had a quarterly report. If you’re very lucky, you might find a fund manager like a Terry Smith who wrote an interesting annual letter. But that was about it.

I would say that is really, really hard to find a good fund manager using that information. What is getting better now is that you’re doing podcasts like this, so you can actually see the whites of a fund manager’s eyes, hear them talk, get to understand their character, get to understand a little bit about what they’re looking for, and therefore find a fund manager who you trust because that’s super-important, but also chimes with the way that you see the world as well.

So, increasingly, if you can find a fund manager interview on YouTube or on their own website where they’re discussing what they do, talking about how they think about the world, that is so much more helpful because, like you say, we’ve got an advantage because we can see these fund managers, we can decide whether we like the cut of their jib or not by meeting them, speaking to them. The manager interview at least brings you closer to that.

Where maybe it’s missing is we still have access to tools, the likes of a Morningstar or an FE Analytics or an AM Insights, which we can use to really get in and look at different time periods, and loads of different funds.

From what I understand, those are still lacking in the retail world. I think that might be a regulatory thing. I think the regulator has a view that the less information a retail investor has, the less harm you’re going to do yourself, which is patronising. I don’t necessarily agree with it, but I would find that frustrating if I were a retail investor.

If I suddenly lost my magical ability to demand to see a fund manager, I would struggle with that inability to meet someone face to face.

Dave Baxter: I guess also sticking on sourcing ideas, I wonder now people may use - you certainly see this with individual shares - social media. That could be a really good starting point too.

Simon Evan-Cook: Yes. Social media, there’s more and more of that. LinkedIn particularly, there’s quite a lot going on on LinkedIn now. It’s changed a little bit from 10 years ago. It used to be just purely a network to network, someone looking for a job, that type of thing.

Now you’re finding fund managers embracing that a little bit more. Your compliance department still gets in the way quite a lot and maybe makes that a little bit more stilted and difficult than it might otherwise need to be. But, yes, socials are a good place to start. Then from that, you can then dive down all the rabbit holes that that brings up.

So, you’re obviously seeing me speak today, I run Downing Fox funds, which are a portfolio of interesting equity funds. So, basically, cheating and cribbing and going and looking at my portfolio is a pretty good place to start, right? Because you’ll find 35 interesting funds there.

You might like some of them, you might hate some of them, but at least it gives investors a starting place for some funds that are different that are out there, and, actually, you can then go and do the work on that and see if you can find more information on that basis.

Dave Baxter: Yeah. It’s an interesting point because I always think that you don’t have to invest in a fund, but you can take ideas from a fund. That can apply to stocks, but also there are many multi-asset funds, and I imagine in that space, a lot of the players will be looking to find these lesser-known, or less readily available, funds and boost their performance.

Simon Evan-Cook: It is a really good way to do it. I always wondered why someone didn’t just start up a complete copycat of the Linsell Train fund because they only trade, what, once every 35 years or something like that? I’m exaggerating, once every not very often anyway.

But it would therefore be quite easy just to look at their portfolio and say, well, I can save myself some money and just buy the stocks they’ve got and I’ll loosely keep up on it.

The thing to say about doing that with, for example, my portfolio is I think it’s a good thing to do, but then I view each of the funds we hold as a line item, if you like, or, you know, a tree within the forest.

So, I understand what each one of those funds does, and we happen to like funds that are quite punchy, really active, ignoring the benchmark, don’t care about what anyone else says, don’t care what a benchmark tells them to do.

If they think an investment is great, but it’s a small cap and it’s not in an index, they’ll buy that. They’re not worried about career risk or anything like that. The trouble is those funds can be quite volatile. They can move quite differently to a benchmark.

I understand that, and I might have a value fund that I know will fall under certain circumstances, but next to it, I’ve got a growth fund that I think will do quite well. So, I understand how that whole portfolio works.

That’s the only thing to say is that understanding from a portfolio manager’s perspective that each one of these is a line item rather than the whole thing.

But I still think it’s a really good place to start doing it, particularly on a personal basis because you don’t have to worry about career risk like we do when we’re running money.

Dave Baxter: And also, if you’re trying to pick out these very differentiated funds as a DIY investor, you might naturally end up straying towards some of those funds that are punchier. They’re doing things that the index isn’t.

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Simon Evan-Cook: Yes.

Dave Baxter: So, you should be aware of perhaps the fact that you’re potentially taking more risk.

So, say, you have used some of these sources, whatever it is, you’re kind of stealing off fund managers’ ideas, you’re looking at social media, you’re looking at the wealth of content that’s out there nowadays, and you’ve come across an interesting fund.

What, then, will tell you that it might be a fund with that kind of edge? What metrics would you look at? What traits do you think would make it stand out?

Simon Evan-Cook: Well, the first thing you’re probably going to notice, and in fact, the reason why it has come to your attention is probably the recent performance.

That’s something, if they’re a long way ahead of everyone else in this sector, if it’s a UK fund that’s a long way ahead of the index, so the FTSE All-Share and other funds, that tells you that they are probably doing something very different.

I think that’s a good place to start, but you then need to be wary that if someone can be a long way ahead of the pack and the index, if the market conditions [change], they can become a long way behind as well. So, you need to be aware of that.

In terms of other things to look at, you want to see features of their portfolios, so the number of stocks they hold. But probably the most important thing is to understand their investment style.

That would be where I start when I’m looking at a fund manager is to understand is this manager a value fund manager? So that’s someone who is not necessarily looking for the best companies out there or the companies that are growing the fastest. They’re looking for companies that are perfectly all right, but the market hates.

It’s a very, very good way to invest, but it has phases where it hasn’t worked. Most of the last decade, it didn’t work, but it’s been working quite well the last five years.

It can be quite punchy, but it’s an extremely good way to invest. Warren Buffett in his earlier years was certainly a deeper value type of investor. He shifted later on to becoming a quality investor.

But again, understanding what that fund manager does and how they think about it will help you to understand, therefore, what the journey might be like and help you then to judge them because that value manager who’s won over the last three to five years, if suddenly the world turns against value investing, might suddenly lose.

That doesn’t mean they’ve become a bad fund manager, and it probably means you want to stick with them, but provided it makes sense why they’re underperforming. So, if suddenly all value funds underperforming the index, that probably means it’s a market thing rather than that fund manager has just lost the plot.

I think this is the really hard bit for retail investors to get a grip of because, again, when you and I are doing it, we can have a look at a value index. So, that’s an index that strips out all the growth stuff and leaves the value stuff, and we can see if that’s moving in a similar way to our value fund manager.

Then it makes sense that they’re either winning by a lot or losing by a lot. Then if it reverses, we don’t get alarmed or we don’t panic sell and we don’t end up doing what is the biggest mistake that retail investors make, which is to keep buying funds that are at the top of the three-year performance table and then get disappointed when they end up three years later at the bottom of the table. That happens over and over again. It’s because you get these cycles of performance within a market.

I think it’s why a lot of people become disillusioned, end up buying passive funds because it all looks like a con. Why am I not getting returns? It’s because you’ve joined in at the point when that style has maybe run its course and it’s due a little time where it goes to sleep for a while.

Dave Baxter: What other traits might you consider? Beyond performance, as you said, style is very important, but what makes a fund more differentiated?

Simon Evan-Cook: You want someone who has got a little bit of rebel about them, particularly if you’re buying an active fund manager because as we’ve just discussed, there will be periods when that works and that’s great. But then when it’s not working, that is so difficult. It’s really tough. So, you want someone who’s got resilience, who’s got the ability to withstand horrific peer pressure. I’ve experienced this myself.

There is nothing worse than the market every month, every year, telling you that you’re an idiot because you’ve bought these companies and you’ve done your analysis and you bought them because they’re cheap, but because value isn’t working, you just look wrong. Actually, you know what? You should have just gone out and bought Amazon and Microsoft like everyone else has.

That makes you look so stupid, but then when it turns, you look brilliant again. So, you do want to find someone who has got a bit of fight in them, the ability to stand by what they believe because there will be a moment when they will be tested solely personality wise.

Dave Baxter: So, we’re looking at some qualitative traits. It might be watching things like your fund manager interviews. Managers differ by how much they do this, but if a manager pens a commentary and so on, you can get a sense of their character, what they’re thinking, their rationale, whether they think they’re just simply out of favour and they’re sticking with a given stock sector, and so on.

Simon Evan-Cook: It’s exactly that. I always say investing is, particularly in funds, an art and a science, but if I could only have one, I would take the art over the science. And that is that sort of stuff. It is seeing a fund manager speak, it’s hearing them, it’s understanding their character, their psychology. And that is best understood through the stuff we were just talking about, the videos, the podcasts, the annual letters.

Dave Baxter: I think you’ve also previously said something about founders being a good bet in terms of funds. Can you explain that?

Simon Evan-Cook: Yeah. I just mentioned that you’ve got an investor who’s maybe got a bit of a rebel streak. You have to have that because to outperform by a long way, you have to, by definition, be different to the market, which means being different to everyone else. Now, those people are very driven, and quite often, they don’t end up playing very nicely with straitlaced tie-wearing corporate governance of a big firm.

Dave Baxter: I’m glad neither of us is wearing a tie as we go into this.

Simon Evan-Cook: I wouldn’t have said it if you were wearing a tie, Dave. I’m not that mean. So, they quite often end up maybe building a bit of a career at one of these bigger firms, but then they end up hating the fact that they’re being told what to do, that they’re being asked to run too much money. So, maybe they go off and start a boutique somewhere else where they can just do what they want to do. So, you get that founder-led way of doing things.

It means they’re running the process that suits their personality. Ultimately, that is what you want from an investor. It’s like any job that you do. You’ve probably done jobs in the past where you haven’t been into it, and you’re probably not doing that job very well. Conversely, when in life you find that job that you’re into and that you love, you can beat anyone because you’re thinking about it all the time. You’re working out the best way of doing it, ways to improve.

I think those fund managers are exactly that. So, the founder is a great investor to go with. And conversely, yeah, some of the fund managers I’ve struggled with have been the next in line, the fund manager who’s taken over from the original founder.

We call this the ‘able lieutenant problem’, which is that they’ve been hired because they’re very bright, intelligent people. They’ve learned everything that the founder taught them about how they should invest, but they just don’t have that knack, that instinctive ability to flex that process, to know when there’s an exception that you should avoid that might lead you into trouble.

So, yeah, the original founder, if you can find that, is a very powerful starting place to go with.

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Dave Baxter: OK. So, let’s go on to examples. For anyone watching this on YouTube, we are going to show a table listing some of the numerous examples you’ve given me beforehand. But let’s just go into a couple of funds and maybe how they’ve stood out.

Simon Evan-Cook: OK. Well, let’s start with, if you’ve got the table up there, you’ll see one called WS Havelock Global Select A GBX Acc. This is run by a guy called Matthew Bedell. Very smart guy and this is almost, if you like, his second career. He was doing an investing job, but a very different investing job before this one, but wanted to become a value investor, he’s a great believer in how that works.

So, he set up his own firm, Havelock, in concert with a manager of that firm, Neil Carter. Together, they’ve created this great team that’s building this business. But it’s a value way of investing. It’s what he believes in. He’s got masses of his own money invested in that as well, which is another thing that we think is a good thing to look for. But it’s running that value stock, so it dances to its own tune.

If you look at it over the last - off the top of my head, I think that fund is about seven or eight years old - there’s been some years when it’s won and some when it’s lost. But what’s been interesting is I don’t think it’s actually had a negative calendar year in its time so far. That includes a year like 2022, when most things sold off.

If you were invested heavily in the Mag Seven in that year, you lost, well, I say lost quite a lot of money, if you held on, you didn’t because it bounced back. But certainly at the end of that year, you were nursing quite bad losses. But this value way of investing worked very well and it worked very quickly in that time period.

So, I like very much what they’re doing. We’ve been backers of that for a long time now, three or four years, pretty much since I set up Downing Fox, we’ve held that fund. And it’s doing a really good job for us, and everything we’ve just been saying about founder-led funds, about people who are very resilient and focused and believe in what they do, absolutely applies to that fund.

It’s global as well, so you’ve got the ability for that fund manager to go wherever they are finding value. So, they’re not tied to being in the US or being in one particular market, they can go where the best ideas are. So, that’s quite a good place to start.

Another good one to look at, and to bring it back to the UK, because I think when I look at the UK’s conditions currently, you are seeing a market that is very polarised.

At the very top of the market, a FTSE 100 tracker is doing really well and, actually, when you look at what the UK market’s done over the last couple of years or so, it’s outperforming.

But it’s only outperforming because of what the biggest companies, which tend to be banks, energy companies, there’s a couple of defence companies in there, but when you look beneath that, when you go into mid-caps and small caps, which tends to be where a lot of active fund managers find their best ideas because it’s less efficient and you might find companies that have got the ability to grow more from there as well. It’s much easier to grow a small company than a really, really big one. You’re finding that part of the market has really struggled.

But conversely, if you’re a contrarian, if you’re the sort of person who always wants to do the opposite to everyone else, there’s not many of us out there, but if you are that, then the UK active space is fascinating currently.

So, we have here the Premier Miton UK Value Opps B Acc run by a guy called Matthew Tillett. There are other fund managers out there who aren’t called Matthew, I can assure you, we’ve got plenty of those. I think he’s a superb value investor.

So, similar style, but this time he’s focused on the UK, delving down to those small and mid-cap areas into what has to be, I think, one of the greatest opportunities currently across the globe. You’ve got a very good market, good quality companies, but everyone hates UK small and mid-caps currently. Matthew Tillett is exactly the kind of fund manager who can winkle out those opportunities for you.

I haven’t seen your table you put up on YouTube, but his numbers may or may not look good compared to some of the other funds on there. But then he’s been in what I think is a far tougher part of the market given what’s happened in world.

Dave Baxter: Yeah. It is quite a disparate mix of funds in different equity regions and so on. So, we’re going to see some, obviously, good funds and some more troubled funds in the mix.

Simon Evan-Cook: I’ve tried to put a mix in there because, again, like I say, these are line items for us. If we ever had all our funds killing it at the same time, that would be lovely. But it would also be worrying for us because when the mood changes, we still want something that is going to rise to the fore to counter the fact that whatever was winning is probably going to have a tough time with it. So, I hopefully put a nice mix in there as a starter, but we hold many more funds than this in our portfolio.

Dave Baxter: The final thing I’m interested to cover is, when you call time on such a fund, it’s up to you whether you want to name names, but obviously, some of these funds have great success and then you run into all manner of problems.

For example, they can become too large. Some of the issues we highlighted at the start of the show. A fund manager is too busy dealing with his clients, with the media, and so on. What makes you decide that the fund with the edge no longer has the edge, or you want to move elsewhere?

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Simon Evan-Cook: Well, the big thing we look at is size. We’re really hot on that because that is one of the worst-kept secrets in fund management, that it is far harder to run a really big fund than it is to run a really small one. And that goes no matter what part of the market you’re in, although, obviously, the sizes can vary.

If you’re running a global mega-cap fund, you can run that probably into the tens of billions. If you’re running a UK small-cap fund, you’re probably going to start to hit the buffers of what you can do at £400 to £500 million. At that point, things start to get a little bit more difficult.

The reason is that when you’re running a smaller fund, let’s say a £100 million or so in the UK small-cap world, it’s big enough that you’ve bought the charges down. So, the fixed amount of charges aren’t a problem anymore because really, really small funds get hit by the fact that they’re not covering the small fixed amount of costs.

The other £100 million, that doesn’t tend to be a problem anymore. What you can do is, if you find a really interesting idea that’s a small cap, it’s not hard for you to maybe make that a 5% position in your fund.

But if you, conversely, are running a £100 billion fund, then finding an amazing small cap, you could buy the whole company and it still wouldn’t make any difference to your fund at all. So, Warren Buffett always talks about the difference between hunting mosquitoes and hunting elephants. He has to hunt elephants nowadays, whereas a smaller fund manager has the plethora of mosquitoes to go out and swat.

So, that’s one of the really big ones and that’s one we’re really, really careful about. Obviously, if you’d have known that and been careful about that, then the whole [Neil] Woodford problem would have been one that you would have been very wary of as soon as you saw the size of that fund and how big it was getting.

Beyond that, yeah, we get an advantage here from meeting fund managers. Maybe you get a sense that they’re not quite as driven as they once were. Maybe they’re not performing quite as well as they should be given the market conditions.

So, if you see a value fund manager who was killing it with a £100 million fund and is now up at £10 billion and maybe they’re still outperforming by not as much, maybe that’s time to say, thanks for the memories and let’s go and find a fund that’s on the beginning of that journey rather than the end of it.

And that is absolutely, again, at Downing Fox, it’s at the heart of what we do is to make sure that we are constantly in funds in that sweet spot.

But, yeah, you can look at other things like ego.

Dave Baxter: It’s quite a tricky one, isn’t it?

Simon Evan-Cook: Yeah, and it’s a fine line because you probably need that powerful personality to fight the market, but then it’s a fine line between that tripping over into a god complex and massive ego, and then the belief that nothing you can do could ever be wrong. So, it’s fine margins.

But I would suggest if you’re beginning to get even the hints of a bad feeling about a fund manager, a little ‘ooo’ moment. That’s probably a good reason to leave and find someone else. Particularly, if you’re winning at that point, it’s probably not a bad time to lock in your gains and find the next great investor.

Dave Baxter: Maybe other things like, off the top of my head, this relates to fund size again, but perhaps the number of holdings rising. Or more consensus positions as well?

Simon Evan-Cook: Yeah. These are all the symptoms of fund size. So, yes, you can find that they used to hold 30 stocks and now they’re holding 60. Harder to find out, but certainly we can look at how much of a company they’re holding.

So, maybe they used to own 1% of a company, now they own 10% of it, which obviously means it’s going to be harder if they’ve got it wrong for them to get out of that stock, particularly without affecting the share price at all.

Other things as well. What is there? Nothing springs to mind off the top of my head, but those are the two I would say that you want to be looking at.

Dave Baxter: I think that takes us to time unless you have any final gems to add.

Simon Evan-Cook: No. Just remember that big mistake, the one about the performance chasing. Be wary of the stuff at the top of the performance tables. It’s a good fund, but it might go to sleep. No reason not to buy it, but don’t be disappointed if it does go to sleep for a couple of years. If you get that under your belt, you’re probably all right.

Dave Baxter: Yeah. Well, thank you for coming in again.

Simon Evan-Cook: My pleasure. Thank you for having me.

Dave Baxter: And thank you for watching and listening. If you want more funds analysis from us, do please look at the website, ii.co.uk. And if you have any topics you want us to look into, any questions, do get in touch email us at: OTM@ii.co.uk. Thanks for watching. Hopefully see you next time.