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How do you assess the performance of your fund manager?

Tuesday 29th August 2017

Written by Martin Upton

The traditional way in which fund manager performance has tended to be judged is against the performance of other fund managers with similar investment objectives. This means that pension fund managers are judged against other pension fund managers, and unit trust managers investing in UK shares are judged against other fund managers investing in UK shares
The Investment Association (IA) maintains a system for classifying funds, as there are over 2000 investment funds. The classification system contains some 30 sectors grouping similar funds together. The sectors are split into two categories, those designed to provide ‘income’ and those designed to provide ‘growth’. These sectors are designed to help investors to find the best fund(s) to meet their investment objectives and to compare how well their fund is performing against similar funds. Each sector is made up of funds investing in similar assets, in the same stock-market sectors or in the same geographical region.
Similar frameworks have been put in place by the Association of British Insurers (ABI) for life company funds and other groups of investment funds. Whatever the framework, the aim of each fund manager is to be top of the league tables, so that new investors will choose them based on past performance. For such managers, success is about relative not absolute performance, and this can affect fund managers’ behaviour.
For example, suppose that you are trying to compare funds investing in cash and UK equities (shares). In a bull market, a top performer relative to the peer group is likely to be the fund most heavily invested in equities. Because of this, there will be a temptation on the part of all the fund managers in this peer group to increase their equity participation. So, over time, the typical fund’s equity exposure will rise, increasing its risk. When the bear market comes, the funds in the group will suffer more than if they had invested relative to a benchmark linked to cash and equity indices, say 50% in each. Staying close to this benchmark would have meant that their equity market risk stayed more or less the same over time.
Retail funds can also be judged against a suitable benchmark index, say an Indian stock market index for an Indian equity fund, or the Morgan Stanley Capital International (MSCI) global equity index for a global equities fund. This makes it easier to measure that all-elusive outperformance, as it is a specified, calculable benchmark return, and allows funds to be judged relative to an established alternative investment strategy.

*Martin Upton is Director of True Potential PUFin

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