How would a client react if their broker or fund manager invested 7-8 per cent of their investment savings into a business, only to see it collapse 45 per cent. Not very happy I suspect although both positions, one could argue, are entirely understandable.
Even after the price fall brought on by an epic environmental disaster, BP is still a 5 per cent weight in the FTSE 100 index. Already I have read an article suggesting Neil Woodford’s genius at removing oil companies from his income funds last year on concern about dividend payout capability although I am certain even he didn’t foresee events unfold as they did.
Consider the index weighting situation. There is regular commentary promoting the benefits of low-cost index investment options such as exchange traded funds over the higher-cost option of active fund management.
There is, of course, plenty of merit in this but fairness at least requires that the resulting portfolio composition is also understood and this would allocate almost 50 per cent into 11 companies, including banks, oil, mobile phones, drugs, mining and tobacco.
Two companies alone, HSBC and Shell, comprise 17 per cent. Of course these businesses are big because they are successful but so too is BP, as was the tech sector back in 1999 and banking in 2008 when these sectors comprised over 20 per cent of the index, only to fall substantially in due course. Such are the realities of the lower-cost option.
The world of active management provides a breath of choice in how to dissipate this risk. Consider the approa-ches of three different managers. Four Capital is a small investment manager offering a fundamental research-based approach delivering a risk-controlled, focused portfolio – UK active fund – predominantly in large cap quality names. GLG has arrived in the UK retail investment space from the hedge fund world and, while also based on fundamental company research offers a more dyn-amic top down macro approach sensitive to short-term investor sentiment with UK select equity, launched in August 2009. Finally JO Hambro Capital Management UK opportunities, another independent manager and this time a fund which reflects the manager’s personal bearish view of the current environment. All three funds comprise around 40-45 holdings – two included BP – all three also outperformed the FTSE 100 by 4 per cent, 5.3 per cent and 8.1 per cent respectively (data from launch of GLG fund from August 3, 2009, to June 11, 2010). By definition, each fund has also out performed the leading FTSE ETF, which incidentally underperformed the FTSE 100 index itself by 1.1 per cent over the same time period.
That is not to say that lower-cost options such as ETFs have no role to play in the multi-manager world, quite the opposite in fact. They are very useful portfolio construction and tactical asset allocation tools when used appropriately but longer term are held back by the small matter of structural underperformance. The price of active management, when one understands the approach and process employed by the specific manager, is a better investment.
Aidan Kearney is co-head of multi-manager funds at Aberdeen Asset Management