Most fund groups close down products at the wrong point. M&G, JP Morgan, Schroders and Legg Mason are among the offenders
What happens to funds with unique selling propositions? Surely they achieve that rare feat of aligning the interests of both investors and managers. Investors should benefit as capital gains are the customary reward for investing in overlooked niches. Managers should benefit as sales are driven by good track records.
My experience suggests that this happy outcome is seldom the case. All too often it seems that such funds are closed down prematurely. However, there is one happy consequence - fund closures can be a useful reverse indicator. Unfortunately statistics are not available to prove this, because no one keeps records of non-existent funds for the simple reason that there is no commercial case for holding data on funds that cannot be marketed.
To adapt the fashion for counter-factual history, here therefore is analysis of some might-have-beens in the world of fund management.
I suspect that many highly regarded investment houses have other skeletons in their cupboards but that they have the good fortune to have escaped my notice. I further suspect there are so many such skeletons that there is a systematic pattern, which has a logical explanation.
Lest readers think I am picking on those mentioned in these case studies below, I should emphasise that they are the houses I regard highly, for they at least dared to be courageous, even if their courage prematurely deserted them.
Case 1: Legg Mason European Telecommunications
Since 2000, I have only recommended one fund in this sector, and tipped that in November 2002 as an exception to the rule.
Unfortunately, in six months the mandate was changed, so I wrote back then "Jeremy Knight is an old hand, with 14 years' experience in the business. But why should one continue to back that fund if the manager has been castrated? Has a reluctant manager been forced into a block trade to neutralise his sector risk? If so, how long will he stay? If not, how long will it take?
"No doubt the decision will be justified as widening his range of opportunities. In truth, it will put pressure on a courageous individual to adjust the portfolio closer to the new mandate. No doubt the marketing people will point to the great track record as justifying the change. That history is now meaningless."
The benefits of focusing on telecoms are apparent from the Stoxx indices graph. While investors still lost money when the bubble burst, their losses were much smaller. They only lost 40% while others lost 60%.
In this case, the manager did succeed in keeping up his excellent record for some time. According to TrustNet, over the past five years his fund fell only 48% compared with losses of 63% by his peers. In the last three years, his investors gained 68% while those of his peers gained only 35%. It is only in the last year that performance has reverted to par, with gains of 22% respectively.
The lesson here is that unique selling propositions inherently offer superior investment potential, because they are by definition usually overlooked.
Case 2: Schroders Value & Growth Investing Styles
At a time when the industry was dominated by discussion about the relative merits of growth and value investing, Schroders was the only house to take this seriously enough to offer their unit trust investors the choice by launching matching pairs of such funds in North America, Japan and elsewhere.
By September 2003 it had lost its courage and merged these pairs into middle-of-the-road funds. Subsequent performance has also been middle of the road. Their Institutional Global Equity and Overseas Equity funds have performed within 1% of their peer group in both one and three-year comparisons, according to Standard & Poor's.
In February, Schroders announced plans to wind up its Global Emerging Markets investment trust. Commenting on the plans Robin Stoakley, managing director of Schroders, said: "The board felt the shareholders' best interests were served by bringing forward the vote." It seems he was wrong. The price has subsequently almost doubled in less than two years, as shown by the emerging markets investment trusts graph (bottom left-hand page).
The lesson in this instance is that the bigger and more prestigious the investment house, the more its fund reorganisation policy can be relied upon as a reverse indicator.
Case 3: JP Morgan Fleming Korea fund
A more likely reason for such closures was revealed by JP Morgan Fleming when it closed its Korean Investment Trust. Here was a genuinely unique selling proposition: a single-country emerging market trust.
Kevin Scollan, vice-president of product development, said "Its size was too small to continue running it as an independent product. It was too expensive to maintain and people were not buying into it." He omitted to mention that, as a closed-ended fund with a constant number of shares in issue, an equal number of investors were not selling out of it. See the Korea funds graph (Below).
Launched in July 1992, the management closed it after a decade with virtually nothing to show investors other than very modest dividends. But it too has subsequently doubled. Had it remained in existence, Scollan's concern about size would have been eliminated. The lesson here is that even if one accepts marketing considerations, they can often be short-sighted.
Case 4: M&G revamp in 2000
For decades, this investment house had a clearly-defined and successful investment formula, namely value investing. Sadly for M&G, that was the wrong game to play during the Millennium bubble. As one of the most courageous adherents of this philosophy, they were one of the last to cave in.
The group therefore reorganised its funds at almost the worst possible time - August 2000. That was just five months after global markets reached their peak. As that happens to be almost five years ago, statistics can be compiled to show actual and probably performance, so calculating the opportunity cost to M&G investors, as shown in the table (M&G fund reorganisation - five-year total return).
Disguised in technical changes to fund mandates, they were designed to achieve the same effect - to remove constraints preventing managers from playing a fashionable investment game.
• Australasia, Commodity and Gold funds were merged into a new Global Basics fund that invested much of its funds in stable growth industries, such as food processing. While the first would have made little difference, the opportunity cost to investors in the other two amounts to almost 100% and 150% respectively.
• European Dividend and International Income funds were re-modelled as blue chip funds. The ratio of value to growth indices has subsequently virtually doubled.
• US and Japanese Smaller Companies funds were merged into their blue chip colleagues. Smaller caps have since outperformed by a half and a third in these two regions.
• The Managed Income fund was converted into a Managed fund. That was an improvement, as the new freedom was used wisely by the manager.
The lesson in this instance is that bubbles only burst when the strongest hold-outs cave in.
The same house that made these changes near the worst possible time now appears to be moving in the opposite direction, at what may again prove, in my opinion, to be the worst possible time.
Launched around the turn of the millennium, the Innovator fund, which specialises in small UK companies, was recently merged into the UK Smaller Companies fund. In that period, technology has been the worst IMA fund sector, losing 66% while UK Smaller Companies has been among the better sectors, gaining 19%. Timing could certainly have been better.
In June this year, the manager of a new M&G North American Value fund said that it makes sense to launch a pure value fund when most investors are turning to growth, because over the long term value tends to outperform. Graph four (Value vs growth style) suggests that may well be true over the long term but not over the medium term. There are clear swings in fashion, and value has never been so fashionable as now.
So the lesson here? If marketing managers will not learn from their investment mistakes, doing the opposite must be an eternal truth of this industry.
Unique selling propositions offer superior investment potential.
The bigger an investment house, the more likely its fund reorganisation policy is to be a reverse indicator.
Marketing timeframe is far shorter than a proper investment timeframe.
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