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Check style before pulling the trigger

When should you fire your fund manager?

Saturday, January 13th 2001, 11:10PM

by Philip Macalister

What's the main reason for firing a fund manager? Most people would think poor performance, but a visiting expert says that is seldom a reason to sack a manager.

"Poor performance is rarely a reason to change," Frank Russell's London-based director of portfolio management, Noel Lamb, says.

He says the main reason to consider firing your fund manager is lack of "organisational stability."

To understand the low ranking of performance you need to consider some basic portfolio construction rules.

A well-diversified and structured portfolio is one built on a combination of different asset classes (NZ shares, international shares, fixed interest, cash and property), and different styles (such as growth and value).

The strategy is to combine assets and styles so you avoid guessing which types of investments will perform well.

The portfolio should always have top performers to pump up performance and counterbalance the dud sectors.

Lamb says poor performance is not a big issue as "managers will perform poorly versus broad market indices if [their] style is out of favour."

This has been shown in recent years as growth has been favoured over value.

As long as a manager sticks to process and style, he says, performance isn't a reason to change.

Organisational stability, however, is important because when you give money to a manager you are buying a specific type of investment. This style is like a piece in a jigsaw puzzle. If it's the wrong piece, it won't fit and the puzzle will look wrong.

It's a big concern for investors at the moment because of the consolidation going on in the financial services industry here and overseas.

When one firm takes over another, there is always the possibility that the two businesses will have incompatible approaches to investment. The fund you are in may change and it will no longer be the correct piece for your puzzle.

Take the recent example of ASB Bank's takeover of Sovereign, and the bank's parent company, the Commonwealth Bank of Australia, acquiring Colonial.

In New Zealand, ASB now has three funds management operations that are totally different. The bank uses a passive, or index approach, while Colonial First State is at the opposite end of the spectrum with its "truly active" approach.

Sovereign follows a multi-manager approach, where it picks a range of managers with different styles to run its portfolios.

Under the merged entity, the three styles will probably be reduced to one or two.

The question for investors is which style will win. Will that style be the right one for your portfolio?

Another example arose when BT Funds Management was put on the market a year ago.

At one stage, WestpacTrust was picked as the likely buyer of BT's Australasian business, provoking research house Morningstar to oppose the deal as it saw it as a bad fit for BT's style.

Fortunately for BT's investors, the business was bought by an American outfit, the Principal Group, which had a very similar approach to that of BT, and there was little disruption.

While the outcome of the ASB/Colonial/Sovereign merger is unknown, the results of the BT sale went from something which could have been bad for investors to an excellent outcome.

Still, there was a point where investors had to decide whether to pull the trigger on the manager.

Lamb says the second major issue investors need to consider when fingering the trigger is people.

While lots of emphasis is put on process, fund management is ultimately a people business.

"It's quite a people business because people implement the process," Lamb says.

He says the issue is more important for small management teams as they are more people - as opposed to process - reliant.

The characteristics of the investment industry encourage change. Fund managers are rock stars in their own little world. The good ones who consistently get runs on the board are paid big money.

What's more, because the pool of good managers is tiny, they are often the target of corporate headhunters.

Also, there has been a trend, in New Zealand and abroad, for the good managers to leave the big corporates and set up their own boutique fund management businesses.

The advantages are that they own the process and profits, and have a stake in the business.

In New Zealand we have seen James Ring and John Phipps leave Southpac Investment Management to establish Coronet Asset Management.

Carmel Fisher left Sovereign to set up Fisher Funds Management and Paul Glass left BT to become a director and manager at Spicers Portfolio Management.

All four had good track records and were widely admired by investors and advisers.

More recently, the AMP Henderson Global Investors lost most of the managers of its UK-based technology fund, in which many New Zealanders have invested.

The managers had almost god-like status after the fund had regularly produced high double-digit annual returns.

The departure of key people triggers the question of what is going to happen to the fund. Should my money follow the manager?

Lamb says three issues must be considered before you pull the trigger on your fund manger. They are:

The costs of terminating.

The costs of switching.

Whether the potential benefits of the switch are likely to outweigh the costs.

Generally, New Zealand funds, do not have exit fees so the first issue is not a major one.

The cost of switching is also minor as many managers will allow you several free switches each year between the funds in its product range.

The problem here is that any switch to another fund is likely to upset your asset allocation, as very few managers offer a range of funds in one sector.

For instance, if you want to switch out of a New Zealand equity fund into another you will have to move to another manager because the original one is unlikely to have two NZ equity funds with the same mandates.

This conundrum then raises the problem of fees. While exit fees are rare, you will in all likelihood have to pay an entry fee of up to 5% to move your money to a new manager.

Whether this is worth doing is a moot point, as the decision is ultimately based on making some assumptions about how well the original fund will do, compared to how well the new fund will perform.

Options for reducing the management hassle of deciding what to do when firms change hands, or key staff leave, is to opt for an investment approach which looks after the problems.

A major one is the multi-manager approach, where a fund employs a group of managers to achieve a certain style. Part of its brief is to hire and fire managers when changes happen.

Lamb says Frank Russell, a major protagonist of the multi-manager style, changes about 12 per cent of its managers each year.

He says it is very hard for investors to keep up with the fund management changes because the "information [they] get is woeful" and the "level of disclosure is shocking."

He says multi-manager style "takes away the risk to some degree."

Lamb says firing a fund manager is often difficult for investors to do.

Often there is inertia - the belief that things may be bad now but they'll come right.

Then there's loyalty - especially if the manager has performed well in the past. And regret.

You can read Philip's blog here: http://www.goodreturns.co.nz/blog/

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