Bigger not always better for fund managers
Successful fund managers invariably attract inflows into their products, but an expanding asset base can throw up a whole rage of problems for these individuals
While investors in general are well versed at analysing fund managers’ performance numbers, it seems that little importance, if any, is attached to the size of the assets that the latter have to deal with in the process.
As John C. Bogle, founder of Vanguard Group, once observed: “Size – present and potential – is a highly important concern. Excessive size can, and probably will, kill any possibility of investment excellence.”
Investment talent, whether built on a forceful and rigorous investment process or gut flair, is rather scarce and thus highly distinctive. Mindful of this fact, asset management firms around the world strive to attract and retain talented people. Likewise, professional fund selectors make a considerable effort to identify and invest with talented investment teams. It is still quite an achievement for a fund manager to outperform the relevant market index over an extended period of time. When a fund manager does so in a consistent manner, the track record becomes exceptional.
Admittedly, relying solely on past performance to gauge future results remains a perilous strategy. However, this metric does play a significant role in selecting a manager. It is also a well-documented fact that performance is the primary driver of asset growth. Empirical studies show that sudden and vast inflows into a fund have a tendency to erode fund performance in subsequent periods.
It is therefore crucial to assess a fund manager’s ability to deliver excess return when faced with an expanding asset base. One simple way of getting a real sense of the value created by a fund manager is to look at what Yves Bonzon, my colleague and chief investment officer at Pictet Wealth Management, calls the “dollar alpha”. Simply stated, this metric quantifies that amount of excess return a manager creates in dollar/euro/sterling terms. By considering the excess return generated and the asset size involved, this simple metric usually reveals a manager’s ability to gainfully cope with a growing asset base.
It would be imprudent to assume that there is an optimal fund size by asset class that fits all fund managers and is essential to achieve consistent performance results. The ideal fund size depends on many factors, which are inherent both to the asset class and the investment style considered.
CLEAR STRATEGY
In any event, it is important to ensure that a fund manager has a clear and persuasive stance with regard to asset size. When asked about asset size limits, most fund managers have ready-to-use responses that are more or less convincing. I have occasionally come across managers who are as seriously concerned about the size of their funds as they are about investment returns. In some cases, these managers have imposed drastic limits on the maximum asset size that they are comfortable with, and they have diligently respected those limits.
I have occasionally come across managers who are as seriously concerned about the size of their funds as they are about investment returns
Interestingly enough, such managers have delivered some of the most consistent returns in the industry. This is not to say that enforcing asset size limits is a prerequisite for a lasting investment success. There are many counterexamples of fund managers who continue to deliver robust performance with a huge and ever-growing asset base. Bill Gross, Jeffrey Gundlach and Michael Hasenstab are just three well-known examples. They have posted strong risk-adjusted returns and continue to do so, despite asset bases amounting to billions and constant inflows.
A fund manager with a stellar track-record will undoubtedly attract the interest of investors. It is fair to assume that such interest is often a prelude to significant inflows into the funds. Still, the main challenge for investors remains how to form a sound conviction on the manager’s ability to cope with the rising asset base and to continue to perform in a consistent manner. In the absence of a crystal ball, the manager’s record in handling such inflows and his opinion on the optimal fund size may prove decisive elements.
Over the years, we have all witnessed highly talented fund managers literally become hostages to the zeal of their marketing teams. The luck of a well thought-out strategy with regard to fund size and flows could have a devastating effect on investors’ assets that the investor can ill afford to disregard.
