Returns linked to style not skill

European fund managers are moving towards growth-based investing, according to research by manager of managers, SEI Investments.

Its in-house analysis has identified this shift, according to Mark McCarron, director of UK, Europe and EAFE manager research at the group.

Its research highlights that managers who outperform tend to be following a style that is favourable to the market conditions of the time, meaning performance has little to do with skill.

McCarron said in 85% of cases, the investment style of a fund rather than the manager's capability is responsible for a fund's returns.

He added: 'When value stocks recovered and began to dominate markets, many of those managers who had claimed skill in the late 1990s found it hard to demonstrate competence. Where a growth style had made these same managers look skilled in the early 1990s, the opposite became true for the later period.'

Managers also find it difficult to time style shifts, SEI believes. The pressures of underperforming when their style is out of favour cause many managers to switch, although this rarely works, McCarron said. He added: 'Over the course of the strong growth period in Europe, many fund managers moved from a core to a growth-orientated style. This move could not have been timed worse. As these managers moved to growth, market sentiment in Europe began to shift to value.'

Highlighting this, McCarron points to the fact that the average growth fund underperformed the MSCI Europe index by 0.54%pa while the average value fund outperformed the same benchmark by 1.12%, during the period October 1995 to September 1998.

He added: 'Those managers who tried to time the growth run would have done far better had they stuck to their original chosen style.'

Benchmark-hugging by managers also ties their style to that of the index. SEI research measured the style bias of 518 funds in the Lipper UK unit trust universe against the style bias of the FTSE All-Share over a four year period to the end of September 2002.

Over this period the group found that over half the funds failed to deviate significantly from the style bias of the index, highlighting the fact that 60% of actively managed funds hug the index.

McCarron added: 'Style effects are often confused with skill and until their impact is fully understood a decision to select a manager can be based on false confidence. This is particularly true in Europe where, as this research shows, the tendency for European managers to drift towards the same style means that anyone who doesn't understand the impact of style will be exposing themselves to only one segment of the market.'

Fund styles are estimated by SEI using a returns based regression analysis to a style factor (growth versus value) a size factor (large versus small indices) and the fund's beta relative to the market.

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