Fund managers have to take a three to five-year view on investment decisions and be isolated from co...
Fund managers have to take a three to five-year view on investment decisions and be isolated from corporate pressures if they are to produce long term outperformance. That was the view expressed by Bob Yerbury, chief executive officer and chief investment officer of Invesco UK, to the audience at International Investment's Channel Islands' Forum.
Yerbury said too often investment decisions are influenced by considerations other than investment fundamentals. He added: "I'm continually reminded, now I'm part of corporate management, not to put pressure from corporate considerations on investment managers. The key thing is to let investment managers make their own decisions about their funds. You must allow them to do so."
Yerbury, himself a former US fund manager, suggested managers have traditionally had constraints imposed upon them as parent companies look to protect their business interests. In particular, he focused on the practice of benchmarking funds against indices. A core part of his argument was that in the short term at least, markets often mistakenly price stocks and sectors according to what they have achieved in the past, not on their prospects going forward.
"Markets often inappropriately extrapolate historic company performance and macro themes into the future," he said. "As a result, they can place insufficient weight on companies' future prospects, overestimate the importance of recent earnings growth and earnings momentum and, vitally, underestimate the ability of companies to change.
"When investment themes and trends continue for a long period, investors start to relax - they begin to assume that fundamental conditions have changed, and that can be the cause of a shattered expectations, especially when the trend has been upward for a long time."
Such a change took place with the market crash in 2000, a point where a number of stocks and sectors were driven up to very high valuations, with the knock-on effect that they began to dominate benchmark indices. Yerbury, however, did not dismiss the index as being of no use, nor did he suggest it would always a mistake to be close to it.
"This doesn't mean that a fund manager should forget about the index - but be aware that major components in indices can become seriously overpriced simply because of the weight of money behind index-tracking and close to index-tracking investors," he said.
Yerbury argued there were times when it made sense to be close to the benchmark, but only when valuations on the major index stocks look attractive. As an example of how this unconstrained strategy can work, Yerbury highlighted a fund he has run since 1995. It has gone from being close to an index tracker, with its peak of index-following characteristics coming in August 1999, to being more and more of a non-benchmark fund ever since.
He added: "You might say that as the fund has looked less like the index, the returns have dropped. But that is more linked to time. We've seen over time that the 15% returns that we were used to in the 1990s have given way to a longer-term 5% per annum, if we're lucky."
With such an approach Yerbury argued fund managers have been able to generate positive returns during both bull and bear market conditions of the last decade. He said: "Unconstrained management can be successful: yes, you need ability; yes, you need talent; yes, you need research. And we all know that in practice that is what clients are looking for."
Turning to today's markets Yerbury noted that investor appetite for risk remains strong, with yields on bonds coming down at the same time as equity market volatility is falling. He questioned whether investors have become too complacent. He said: "There are significant imbalances in the global economy - for instance, the twin deficits in the US. The downward trend in interest rates has boosted asset prices including houses, bonds and equities. But will there be a correction in global housing prices? What will be the impact on consumer expenditure?"
Invesco's research also suggested the oil price has risen by 300% since 2001 and Yerbury questioned how much longer this upward trend could continue before it impacted on the US consumer. Over five years the top performing group within the All Share, Tobacco, has risen by 157.9% while the worst, IT hardware, has fallen 96.4%. Yerbury predicted disparity in sector performance over the next five years could well be just as high.
Markets often extrapolate past performance and assume, incorrectly, that the future will continue the existing trend.
Only in the long term do markets reflect fundamentals, in the short term they do not, as they are too influenced by noise and over-reaction.
This means sectors and stocks can be hugely overvalued or undervalued.
Vital managers take a three to five-year view on stocks.
There is nothing wrong with following the benchmark if the main components are attractively valued, the trick is knowing when to move away.
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