Merryn Talks MoneyDowning Fund Managers’ Simon Evan-Cook joins this week to talk about the case for active versus passive investing.
Cook says Jack Bogle, founder of The Vanguard Group and arguably the father of passive investing, did “more for individual wealth than anyone in history.” He deserved a knighthood for creating a low risk, reliable and comprehensive way of investing, Cook says. Nevertheless, the fund manager explains why he’s an investor in active funds, and discusses how to find the rare manager who might make you real money over the long term.
Bloomberg Audio Studios, podcasts, radio news. John Man, you know, we were chatting before we started recording, and you said something I didn't think i'd ever hear you say. You said just a matter of seconds ago, so you can't deny it. You said, you know, those charters they're onto something. I think they're right.
I will, I will. I'm more than happy to acknowledge that I am proudly chartist.
Curious.
It's one of those it's one of those great things where see you, if you're talking to someone who's a nervous financial journalist, one of the first things they'll say is this charting stuff's just a lot of hocus pocused nonsense. But once you've been kind of in the markets for wile, we realize that it is as good a way to analyze markets as anything else. And if you are actually looking at markets on any time horizon that is not amenable to fundamentals, which is practically everything from five years down, then technicals are about the only thing you've got, and that a really good reflection of behavior and psychology in the market. So yes, I say, I am. I have a lot of time for technical analysis, and you're.
Talking to someone who once wrote a column, admittedly a couple of decades ago, about how the movements of the moon could influence the stock markets. I'm sure that, by the way, I still have some sympathy for the idea. I still have some sympathy the ideas. I'm definitely chart is curious as well. And of course, I mean this is really just about momentum. And we started talking about charting before we started recording, because I was telling you about a conversation I'd had with a fund manager and we were talking about executive pay and all this fuss around, you know, ocado this week and stock exchange last week, etc. About whether it's reasonable for CEOs to be paid ten to fifteen million pounds year, admittedly less than they get at the top in the US, but nowethertheless, you know a lot of money. Is it reasonable? Is there a link between pay and performance? I mean, it's such a boring conversation. We have it over and over and over and Overright, you can find a study to back up either side whenever you like. Anyway, having this conversation and I said to him, well, you know, do you is this the kind of thing that might be a catalyst for the market what would make the UK market go up properly? And he said, well, what will make the market go up properly? Is it going up? Because all fund managers, all fund managers, whatever they tell you in the end, are to a degree momentum investors. And that's particularly the case with global investors. They won't buy something because it's cheap, they won't buy something because it's interesting. They won't buy something because of some sort of macrofaf They'll buy it because it's already going up. That's it, That's all there is.
Yeah, and I mean benchmarking leads to this. You know, it's like if some's going up and you're not in it, then chances are you're going to be in trouble the next time you see your investors. So it does encourage it. And at the end of the day, the foot SAE one hundred has now going to a new high a while at the same time, the S and P five hundred has come off the boil, which I think is also important. And you've also got like this massive merger deal with BHP buying Anglo or you know, trying to buy Anglo, so that's suddenly drawing a load of attention to it, and I mean, to be fair. What's his name, Nick? Of course, sorry Nick? Nick Train said that to you the other day. You were mentioning that on last week's podcast the catalyst was going to be a foot sae one hundred deal, and you know, I think that's a reasonable point. So it's in the news. It's going up. Suddenly people are saying, wait a minute, maybe maybe the UK is not a complete disaster after all. So yeah, I guess.
Yeah.
Charts reflect psychology, and the psychology hopefully possibly has changed. Goven that the fundamentals are already there. No, we've been saying for ages that is cheap. So if it needs a catalyst, then a new high and a big deal sort of makes sense.
Is that what your chart tells you? John?
Yep, yep, New highs, beget new highs. That's what they always say, until you hit the next febnit tee number. That's properly, that's properly getting the right twisted.
Okay, So marcuts go up because they go up. You heard it here. First, tell your friends. I wanted to ask you another question, and I don't. I don't know if you if you haven't looked at this, don't say anything. But John, a few weeks ago, maybe a few months ago, now, you wrote about China and you said you wouldn't buy it because it was uninvestable from your point of view, but nonetheless you thought it would probably go up and now would be a good time in the cycle to start buying into China. And that kind of looks right, doesn't it, because China is at the very least stopped falling.
Yeah, and it did go up since then. I hate them out. Haven't properly looked at the chart. It's the exact team that I said, you should buy it if you have no models.
I only ask you, John, because I've been reading a little bit of research from gav Cal Research where they have this great little bit of research they put up every now and then where they just ask questions and answer the questions, and one of them is about China, and they're pointing out that even a couple of months ago, bad news would have pushed equities down ten twenty percent drop of the hat because everything was bad and everyone was pulling out. But now lots of nasty macro developments for the Chinese markets. So a strong US dollar, rising treasury eels collapsing again, except when these are the kinds of things that in the past would have made the Chinese market go down, down, down, but now it's just kind of fair going up, and so they see a momentum driven shift there as well. So if we would go back to your charts or the moon, we may find that we're being told there that right now, while we might continue to say that China is uninvestable, its behavior is slightly different.
Yeah, And I mean that's kind of the piece at the start of the year saying that it was the most obvious can trade and trade for twenty twenty four and that I still wouldn't put my money in it, but you know, feel free, and yeah, it looks if it's done, okay. I mean the other interesting thing I noticed was that, and I haven't read the actual piece behind this, but Goldman Sachs were apparently saying expected rotation now from unfortunately from Japanese stocks into Hong Kong stocks, and I thought that was an interest in coll because I also saw a note from my chap that we both knows friend lorenz On LinkedIn the other day where he was saying he's just current on a research trip in Hong Kong and a guy he was speaking to there was saying that he's had a lot more fund managers coming to see him asking about Hong Kong stocks. Then, you know, I think the same number in the quarter as he normally sees in the whole year. So I think there's definitely a sense of chasing around for things that haven't gone up, because beyond that, it's hard to see the micro story hasn't really changed that much. Is more just at the point where people are thinking.
Why not.
And I guess also with the S and P getting a little bit, I don't know, it feels as if the mootor has changed slightly and maybe they kind of lagguards, which is basically the rest of the world are going to start having the time in a sign I don't know.
And you know you need in this kind of environment, John, what's that?
Sorry?
You know what you need?
And what do we need?
What do you need? You need an active fund manager?
Ah, that's a good transition out like that one, Thank you, thank.
You, so moving on, So my guest this week John is Simon Evan Cook, who I've known for a long time now. I've been reading his research for fifteen years or so, and here's someone who really really knows about active fund management and how to pick a good active manager. Which is why I wanted to have him on at this point in the cycle, because it definitely feels to me like all change in the mind is everything widening out, everything moving around, magnificent seven in the US losing momentum. It looks like it might be if you're interested in this kind of thing, time to think about moving away from passive investments into something a little bit more active. It's very good at it, so that's why I asked him on.
Well, I mean, I'm looking forward to here in this one because it is probably the single most controversial topic in investing active versus passive.
It's emperting, isn't it? Because you and I we got you know, years ago as soon as that when passive really began to take off. We were so pro passive because we were so thrilled to see something that there was cheap and that would drive down fees across the industry. And it did exactly that. It's been a brilliant product for millions of millions of invested, Absolutely fantastic. But there comes a point, doesn't that, and I'm obviously two ear leagues that have been with everything for the last three or four years, I've going, oh, I don't know, that's a bit much passive. Maybe it's time for a shift. Maybe it's the age of the stock picker is back with us. Time to go back to active. One of the reasons why it's safe to go back to well say further than it used to be because fees have come down so much. And when you look at the fund when you're looking to invest, you look at the vehicle. The only thing you can know in advance is the compt You can't know anything else. So in the old days, when you look at a fund and you're like, wow, one and a half percent really And then of course in the old days there with that to you know, you had to pay that drag to your IFA for decades and all that kind of thing. It was super expensive. So the only thing you when you looked at it was wow, this is going to be a real drag on my performance, whereas you looked at passive, you know, not going to be such a drag on my performance. So the choice was kind of easy.
Yeah, And I think it's interesting that the debate has become so polarized because passive took off to such an extent. But since those days when we were talking about it, the course on the active said half come down substantially. I mean, so you know we're talking maybe like twenty years ago. This was when I fees, as you said, well, basically getting paid commission from find managers for selling the products in their behalf. That will win out the window. Thankfully, the act of funds one more expensive and once ther came along and the passive competition that started to drive down the course of the active funds. So a lot of the arguments that were extremely cut and dried back then are not as cut and dried now. And yet the argument I would say has become far more will polarized. Basically, there's almost a kind of passive, kind of puritanical streak. In fact, I think we'll get more hate mail about this than we do when we see nasty stuff about MMT or bitcoin.
And that is saying, some.
Gosh say something. They say something nasty about Scottish politics, if that gets us more hate mail. But no, you're right, it has become a bizarrely polarized conversation and a conversation that is less about, you know, if there's a good way to combine the two, or a good way to use one in fun parts of the cycle and one another parts of the cycle, etcetera, to a complete division between only or only active. You're interesting anyway. Simon knows all this stuff, So we're going to move on to talk to the expert. Welcome to Maren Dogs Money, the podcast in which people who know the markets explain the markets. I'm there in Sunset weeb Here's my conversation with Simon Evan Cook, fund manager at Downing. Simon has more than twenty five years experience in the investment industry. Career started a long time ago at Fidelity before joining Rothschild Asset Management and then gartmore on to Premier Asset Management in two thousand and six. And this is where I first came across Simon and where he built his reputation as a member of an award winning multi asset team there and also wrote the fascinating research that we refer to pretty much all the way through our conversation. In twenty twenty two, he joined Downing to set up a manager Downing Fox range of funds, Simon, Thank you so much for joining us today.
Hi, Maren, glad to be here.
Now we have got a lot to get through, but I want to set us up by asking you to talk a little bit about you're in active manager. I think maybe clear now you're an active manager. I want to shut us up by asking you to talk a little bit about the rise of passive and what it's meant for the investment community as a whole.
Yes, absolutely so. It's something I've come to peace with. If you've ever read any of my stuff, you know that I'm a massive advocate of active investing. I'm not an apologist for all active investors. I'm only an apologist for the great ones. So I think that's all we should be concerning ourselves with. But when you look at passive and the rise of it, it's something I've come to peace with recently. I used to almost attack anything passive just in the name of active, but I can now see that if Jack Bogel, the founder of Vanguard and basically the kind of father of passive investing, was a brit I fully concede that he should have been knighted, because he's probably done more for private or small individual wealth than anybody in history, because that product is a great thing, and it originally came about to solve a problem, which was that go back to the sixties and you had a lot of brokers and wealth who were picking I don't know, let's say twenty stocks, and those stocks would go up a lot, and then they would claim that was down to their skill. Now, of course, all stocks basically go up nearly all the time, so you could have bought anything and it would have gone up. So how do you know if that person was actually conning you or any good at their job at all? You didn't basically, whereas obviously the rise of benchmarks and then passive with that gave people an option to say, well, hang on a minute, mate, you're not actually picking good companies, so you're just buying any companies and then just conning them onto me. So the launch of that was a great thing. It's clearly gone from being a kind of disruptive small product in the seventies all the way through to where it is today, where it is he behemoth. It's a juggernault. It's various reports have the passive part of the market being more than fifty percent now so on that level, it's been an incredible success. But along the way you've had bumps in what it's done and how it's been perceived. But you're also now getting to the point where it's so huge that it's becoming potentially big enough to have its own impact on the market. And that to me is it's certainly raising a lot of concerns.
Yeah, but let's stick with the core success before we beginning. And one of the things that's happened here is is enabled a lot of people to come into the market cheaply and easily track a benchmark, feel like they're doing everything. It feels low risk, it feels comprehensive, it is cheap. And I went on a podcast the other day which is aimed at beginner investors and people just beginning to get to start in the markets, et cetera. And their default advice to all investors is just to buy a global index man and be done with the whole thing. And that has been excellent advice for quite a long time now. You couldn't really go wrong with that, given that the US market just goes up and up, and then a global index treker is what about seventy percent the US, So you've got a lot of exposure in there, to the Magnificent Seven, to the big tech socks in the US, you've got a lot of exposure to the rest of the US market and very little exposure to the areas and the rest of the world that have been languishing around the place. So you've made good money, you haven't paid very much for it. That's been great. And at the same time that passive industry has put a lot of pressure on the rubbish parts of the active market, right, So Yes, work to bring down fees across the board because if you can get if you can get a good etf for a couple of basis points, why would you want to pay one and a half percent for allows the active manager, Alice, put pressure on that part of the market that you and I have often talked about before, the sort of the closet tracker, the active managers who are to actually activity all Yes, the tracker and they've paid, and they charge you more. So there've been great successes from passive before we look at the overall impact on that it might now have on the market for the individual inveasta. So far, the rise of the passive industry has been and I feel like you conflicted about this, but it's been a very good thing.
Absolutely absolutely Now argument for me, it's just it's a simple, reliable product in a world that is endlessly complicated and for but a certain type of person. I always compare it to if I was ever asked God forbid to go on strictly come dancing. I have two left feet. If someone said at the start, you don't have to do the dancing, and we'll bring you in seventh out of twelve, I'm taking that all day long because I'm not a dancer. So for anyone who's not interested in investing, hasn't the time, expertise knowledge, it's been great. But it's where I've had taken issues with sometimes suggesting that everybody should go passive, and that's where my back starts to get up.
So I talk me through a little bit. When you say reliable or what do you mean? You mean you always know what's in it?
Yeah, you know what it's going to do. So I always talk about the two degrees of separation, and what I mean by that is how do you separate someone from their own money to being invested. Now, if you invest in just a passive fun I think you've got one degree of separation, which is that you have personally bought the market, so you only really need to consider whether it was the right thing to have bought the market. So there's only one kind of area where you could have it made a mistake, which is you bought it or you didn't. If you then bring in an active fund manager, you've got the second degree of separation, which is where you've got that market decision. But then you can also blame yourself for having picked the wrong active fund manager. So you've got two areas where you've got room for self doubt, and that, to me is the big difference, and that's where a lot of people can fall down, is that you've end up a lot of cases buying a very good active fund manager, but you just buy them at the wrong time, And that to me is the problem a lot of people have with active fund managers. They're very good at picking good fund managers, they are just appalling at timing it because they will buy them after the fund manager has done five years of good performance, and that invariably heralds two or three years of poor performance. That's a feature of a great fund manager. It's not a flaw, and so you end up just experiencing the downside of these fund managers, the bits where they underperform. And you do that once with a growth fund, you do it twice with a value fund, and then the third time you think it's all a giant con I can't be bothered anymore. Are just go passive. So there's more to understand if you're buying an active fund, which makes it more complicated. But that doesn't mean you don't need to understand what's in a passive fund, because yeah, for most part it makes sense and it's been a great investment. But there are certain times, and there have been certain times in history where what is contained within that benchmark can become dangerous and make the whole thing more dangerous than maybe you imagined it would be.
We're going to come back to that bit, but I just want to ask you something. I have memories of a piece of research that you wrote a while, a long while that probably about how we always say that active funds on average underperform the market, But it may be that investors in active funds on average do not underperform the market because they're better at picking active funds than you might think. And if there are more of them in the big successful ones, then there might be in the others. Then it's entirely possible. And I remember you doing some researcher back this up. It's entirely possible that the individual retail investor on average does not underperform.
It is, Yes, I do remember doing that. Yeah, I went deep geek for a number of months and recreated my own sector averages. Because when you look at when you see a lot of stats, the commonly used stats of the industry about active funds or funds in general, it doesn't apply any effect of the size of those funds are on performance, and so that can change the picture massively. I remember at the time, so we're going back ten years now, and I think I've just done it after a period when there'd been quite a bit of turbulence in emerging markets in Asia, and at that time you saw that actually the average Asian equity fund had done pretty badly, had underperformed the markets most people would have expected it would have done. But when you look within that and you looked at who the big funds were, and at the time, this was when firms like Steward Investors or even Aberdeen were the kind of fan favorites, the ones that were widely held. They were amazing funds, particularly the Stuart Investor funds run by Angus Tulko. I know you're aware of a lot of people back him. There was a lot of money invested in those and that meant that actually more people in that sector were benefiting. And actually you saw that active management was doing an amazing job for investors in that part of the market because everyone to have picked the great fund manager.
Yeah, so that makes all the difference, or could make all the difference. Yeah, Okay, let's go back to then what you were just talking about times. And obviously this is the first time in the history of markets where we've reached any point with this percentage of assets under management inside passive, So we haven't got that much history to work with here. But there may be times, and possibly this might be one of those times where passive isn't the best place to be. Is that a fair reflection of what you're thinking?
It is, absolutely, Yeah, it's something that would worry me about holding a pure global equity track, or particularly a US equitary tracker currently. Is that level of exposure to a handful of companies like The great advantage of or one of the great advantages of passive funds, is that they are supposedly diversified investments. You should have a lot of stocks, and you shouldn't have too much invested in any particular one stock. But every now and again, certain indices become very heavily concentrated in certain stocks. So go back to twenty ten, if you happen to be tracking a Latin America index, you were basically twenty thirty percent of your money in two or three oil companies or natural resource companies. Today we face a situation where the concentration in the S and P five hundred in am using turn of the year statistics. This has changed a bit since then, but in those Magnificent seven is twenty nine percent. So you got twenty nine percent invested in seven companies that are, to all extents and purposes variations on tech. Now you compare that to two thousand, which was the last time I think risks are built up to this any kind of this type of level that is more concentrated. So twenty nine percent today it was about twenty one percent in two thousand, and also in two thousand you had companies like Exon or Walmart which were in that top seven as well, which were diversified at least they weren't just tech companies. And I think that is a really instructive period, that two thousand because in the long march of passive from the nineteen seventies through today, that it's tempting to think of the whole thing as just a straight line where everyone has just been consistently buying passive. But it went into recession from about two thousand to two thousand and seven. Actually people were net selling Vanguard's biggest s and P five hundred tracker after two thousand. That was because of how badly it had done versus most active fund managers. And the reason for that was because it's concentration in megacaps, how expensive those megacaps had become, and then what happened in two thousand when all of that turned. It's quite a sort of instructive lesson for those of us who are interested in history.
So could we say that over that period in general active outperformed.
Ah, yeah, absolutely you can. I mean it was the time of when a lot of legends made the names in the UK. Anthony Bolton was the one that came forward. Already mentioned Angus Tullock. I'm not sure if I should mention his name, but Lord Voldeford became of age at that time. He was did an amazing job for investors at that point. Obviously we know how that ended in due course, but it was a period when those investors had been brave enough and stuck to their guns and believed in fundamentals and value and all that stuff, and had therefore avoided those megacap growth stocks that were too expensive just shot the lights out over the bear market that followed. You had Anthony Bolton in his UK fund actually made money over that three year bear mark. It wasn't just that he fell by less than the mega caps did. He actually made money. And then obviously in the ballmarket it followed, they absolutely went to the moon that the returns you got from the likes of a Fidelity UK special situations were orders of one hundreds of percent better than you were getting from a Gloebil equity tracker at that time. So it really was the last real golden age of active fund managers, and conditions for me look very similar to how they looked in two thousand.
So I suppose to be clear, we should say that if you stay impassive right now, you're going to have a very big exposure to these giant companies. If they turn you're going to lose a lot of money. And at the same time, maybe that active funds that have the freedom to go wherever they want find the best opportunities are not in those giant dogs, and you may find that you perform a long letter, I'm just trying to be simplistic about this.
Yeah, there's a case study that I always use, which is and I remember this. So I started in the city in ninety six, ninety seven around then, and I remember at the time seeing buses advertising what was called the Mercury Global Titans Fund. I mean, amazing name for a fund. It was basically it was a bit of a closet tracker, but it was tracking the dal Jones Titans fifty index, which had performed amazingly coming into two thousand. The marketing people loved it, so they launched this fund and to a great fanfare, and the message was you'd be stupid to buy anything other than the world's biggest and most powerful companies. Why would you do that if you were buying anything that was domestic, or that was small, or it was UK or that was value. You're a bit of a square and you've missed the plot, and all that stuff is risky, and the big stuff is very safe and it's going to make you a ton of money. Mercury, who were later bought by black Rock, launched that fund. I think it was in March two thousand. It wasn't a badly run fund, but it lost you fifty percent of your money over the next three years and it didn't even break even. Seven years later, it was still underwater. And because of the weight of those fifty companies, the Global Tracker did a similar thing, lost you best part of fifty percent, and then it took you seven years from the turn of two thousand to two thousand and seven to break even again. And that is a long time to have made no money whatsoever.
But when fund was launched, it must have felt like it's felt over the last year or so, that there really isn't any choice but to hold these very big companies because if you don't, you're going to underperform. Sleep everyone in a track of any kind is holding them but active funds as well, if they're not holding them at least at the benchmark level, they're going to underperform almost by default. So if you're an active fund manager, if you're an active fun raannger and you've been sitting there for the last three or four years, going that stuff's too expensive, I can see the concentration. I'm worried about this. Valuations are too high. It's been a disaster for you.
It has been a disaster to the point where you've either given up or you've been sacked, or you're one of the very few who've managed to sit it out. And those are basically the fund managers them after because they're very conviction driven. They believe in what they do. They know that you should value a company, that you shouldn't get carried away, that you shouldn't just copy what everyone else is doing. But they become a vanishing breed as time passes by. And again, yeah, to take it back to the Anthony Bolton thing, that's what he was. It's one of the few who managed to survive with his job intact and allowed to continue doing what he did. And then you just saw the dividends afterwards when the world turned as it always does, and then he had.
That disaster, didn't he It's not for today. But when he launched the China Special Situations Fund and everyone thought he was a god and then oh yeah, wrong, didn't it round and around? It goes in active fund?
It does to say it, But he was I would defend him on that. He actually, contrary to popular belief, actually beat his benchmark over his tenure on that fund. He just didn't do anywhere near as well as he'd done in UK Special sit So he's got a bit of a bad rep for that. But yeah, compared to what he'd done on the UK side of him, it was a pale limitation for sure.
I just remember being cross about the charging structure. Anyway, a different story. Well, he won't go back to that now. So let's talk about the survivors, right, Let's talk about this premise that that you have and that I have huge sympathy with, and I think you're absolutely right that we're coming to the end of this great run for these huge companies and and for the modern titans, and a shift in the assumption that passive is always the place to be. So who are the fund managers what is the fund managing companies and the managers who have survived this period and you think are going to come out the next decade and give us another mini Golden Age or maybe mega Golden Age for active fund management.
You could find them in any market. They are still around. A lot did fall by the wayside, but a lot have carried on. You can find them in big houses. They're likes, you know, the Schroder Value team, a very good team because they've got a support network there and they've got a good story about it. So that's a good place to look if there's a big list of them. If you go on our website and look at our funds and our holders, we're very open about funds that we own because we like the fund managers. We invest with them, we want them to do well and we want them to raise assets. If you were to look through the UK, you're going to see names like Castle Bay in there, like Gresham House, like Cape Wrath. You're going to see very sooner fun from Tyndall. You're going to see I'm going to feel bad now because I'm going to leave someone out and they're going to be quite cross with me. But yeah, there are these are basically if they've got anything in common, they are obsessives. They're people who loving them testing and would be horrified to think that they are going to end up just copying the market.
Well, and some of those ones you mentioned are very small. I mean Kate Rath for example. That's a tiny fund, doesn't it It is?
Yeah, very small. I think there's a big misunderstanding in the industry that a small fund equals a risky fund. To give you an example of a fund we held in the past, which is tv IT. It's Edinburgh based Smaller Companies fund. We don't currently hold it because it's had manager changes, so it's just watching that as it beds down. But when in my previous job, I was in a company called Premier Might and we had a lot more assets under management. When we first bought that fund, it was about five or six million pounds in size. Tiny, yeah, but all of that money was the fund manager's money. We put forty five million pounds in it and a lot of people gasp begin to take a breath when they hear that amount. What you held forty five million of a fifty million pound fund. But it's like the old adage about banks. If you owe the bank a million pounds, they own you. If you own the bank ten billion pounds, you own them. If we're the owner of a smaller fund and we know that we're not about to sell because we're not flaky investors who are going to run for the hills at the first sign of underperformance, and we know that the other money is the fund manager, then there's no liquidity risk like there was with the Woodford thing. The Woodford thing was because there were bigger holders who are perhaps didn't understand the way the fun worked, the way it was supposed to work, and they all ran for the exits at the same time. It's not about the size of the fund. It's the important things about what is held within the fund. You need to make sure that the stocks that are held a liquid and an appropriate for the size of that fund. For example, a five million pound fund that owns megacaps. That's a good thing because if the fund needs to close down, they can sell it within the next seven minutes. It's not an issue. The problem and why people are paranoid about small funds, ironically is again because of the Woodford scandal, which is weird because it wasn't a small fund. It was ten billion pounds. But again it wasn't necessarily the size of the fund so much. Has the stuff that he was holding unlisted massive stakes in tiny companies. That's where the liquidity problem came from. It wasn't because the fund was small, because it wasn't a small fund.
Have you signed up for Woodford Views?
I saw that came out. Yeah, that's gonna yeah. Fun enough. Our firewall at work is blocking that, which may be a bit of satire or commentary. I don't know, but I haven't been able to see it yet. I'm intrigued.
There's nothing to see it. Don't worry that your firewall hasn't punished you in any way it normally does. The first few hasn't come out. There's still time, all right, Let's go back to small funds because I've written quite a lot in the past, and I think that you've had input into these columns. I've written in the past about how to find a good fund manager, what's what of the parameters to look for in the fund, And one of the things that often pops up is that actually funds run by excellent managers tend to do particularly well in their first four or five years. So when there's small, when they're new, when the fund manager has their best ideas, A good manager is going to launch a new fund when they see a great opportunity, right, They're not going to just do it randomly into an average market. They're going to say, there's a reason for this, and I can see it. And so those first four or five years when the fund is small may actually be the best ones to be invested.
Absolutely, there's reasons for that in terms of motivation. Maybe the age of the fund manager. I think there's a kind of mistake and belief that you want an old fund manager. There's nothing against old fund managers, but actually I think there's a sweet spot for fund managers where they've got enough experience and maybe they're into their thirties or the forties, but they've still got the enthusias and they're still building their track record. They've still got a point to prove, and to me, that is the real point to own a fund manager. And quite often that's the time they're running their first fund, or it's the first opportunity to go outside of a big company that we're at and begin something that is truly represents the way they think that it should have be done. So there is a human element to it, but there's also a fund size element to it as well. Now we've talked about the benefits of big great funds, but the only thing that's better than a big great fund is a small great fund because as a fund manager, it's so much easier to run a smaller fund finding better ideas and small caps and typically that's where you're going to find better ideas, less efficient part of the market, more room for growth for smaller companies to become bigger companies. Then having more access to that and the ability to come into and out of stocks without moving their price too much is a massive advantage. So absolutely all of the experience I've had in the past of when we've outperformed as a fund of funds has come from finding fund managers who are at the start of that journey rather than at the end, because all of the advantages are stacked in their favor. And the real benefit currently is that because the rest of the market, the UK fun buying market because of consolidation, because of a whole load of other stuff that's going on, career risk herding sheep like behavior. No one is prepared to buy these smaller boutiques because I don't know, they're all afraid of getting egg on their face because they're back to a fund that was operating out of the barn in Oxford, or they were.
It wasn't something You've got to let this go, simon, I know you gotta let it go.
No, I don't. I never have to let it go, absolutely, But the point of being that now these funds are offering much better fees. So the classic fee for a boutique fund going back fifteen years is one and a half percent. We're typically now paying half a percent as an early investor in these funds, which we're obviously passing back onto our clients as well. So I don't need to let it go now. I can just benefit from the great performance and have less of it eaten away by our fees.
As tough for a new fund manager to survive on fees that low, I mean, I'm very pro fees as low as possible, But if you're launching a new funded you've only got or you mentioned TV eight earlier, starting with five six million, surviving on fifty basis points, and I'm.
Unbelievable well, it's tough, right, It's tough. It's and it's wrong as well, because I think a thriving market, any market, it doesn't matter whether it's a financial market or a product or whatever it is, you need a lot of entrance into that market to give you choice. But we are now in the unfortunate situation where because of regulatory costs and the pressure of people not being prepared to kind of risk reputation and back a new fun it means that you are only getting funds who have got tremendous backing behind them. So they've either got personal wealth for they know a lot of rich people, or they're having to go to a company and if effectually give away their own kind of IP and skills. So it's unbelievably tough and it's not healthy for the funds market for sure.
Okay, let's talk a bit about the other things to look for when you're looking for a good fund. Let's start by saying that there is this idea that a smaller fund is better. So let's say we're an ordinary retail versitor. We're out there thinking I'm going to go a bit active. Now I get this, I understand what Simon's saying, so I'm going to shift some of my money away from passive into actor. I like this idea of looking for a small fund. I get that. What are the other parameters that people might take into account?
Well, I mean there's technical parameters, but then there's obviously human parameters. And so to give you a good example and to keep it relevant to what we're doing today, I know you spoke with Jonathan Asante a few months back, and I suspect if you scroll up you'll see his podcast. Basically have a listen to that. We don't back Jonathan Asante's fund yet, it's a relatively new one. We're looking at it, but he is exactly the type of fund manager that we like because he's entirely trustworthy. He's entirely focused on a particular way of investing that we know works in the past. And so if you can get access to hearing that fund manager talk and hear it or reading about their philosophy, and we've all read the letters of Warren Buffett or a Jeremy Grantham, and what comes across is the consistency their trustworthiness, their kind of focus on what they do. So those human factors. If you find a fund manager who fulfills all of those and has done it for a while and you just have a good feeling about don't dismiss that just because there's not a kind of mathematical factor behind it. Absolutely, that's important, and it's the biggest part of what I do. I'm lucky enough to be able to meet all these fund managers and see the whites of the eyes if you like, but that's essentially what I'm doing. Can I establish trust with this far manager? Do I believe that they're sort of and won't turn the heads and give up and invest in the global titans when they should be buying Japanese small caps.
Yeah, because that's where a fum manager can become unreliable. Right when you talk about the reliability of the passive, you know what they're going to keep doing. Whereas you can choose a fund manager and he can effectively be unreliable. You buy the fund because you think he's a solid value investor, and next thing you know, he's chucked in the towel and brought in video.
Yeah, exactly. That's the thing to watch out for. Aubert's warning signs that if you've bought a UK small cup fund and you see in video on the top list, then it's not a UK small cup value fund anymore. So it's yeah, there are little bits and pieces like that, but by and large, I think people's instincts about what is a good fund and what is a bad funder, right, it's just the timing that they foul up too often.
What about the extent which a fund is active? How active does an active fund have to be to be considered active? Right? So you get a lot of funds out there that call themselves active but relative for the benchmark, but'll maybe a bit closer than you might expect. I think when we've discussed this in the past, you've talked about it being reasonable for a fund that called itself active to have what they call an active share a difference relative for the market of something in the region of seventy eighty maybe higher, whereas if you're down at say fifty or sixty, whereas it where you're pretty close to the market as a whole. So maybe you're not a fully active fund exactly.
We look at a kind of cut off probably at about eighty percent. We might have one or two that have DipEd slightly below that, but not a lot. We're only interested in finding the active fund managers, and active share is a really good way of doing it. Basically measures What that eighty percent refers to is that if you look at you compared the fund to the market, eighty percent of it is different, twenty percent of it is the same, so they've got stock overlap with a few stocks, and so it's different enough. Our average active share of the funds we pick is ninety three percent, So we really do go for it in terms of we want active fund managers in terms of the theory why that works. Basically, what you want is someone who is just trying to find good ideas. And again we've mentioned nagus Tell a couple of times. I always remember one of his rules was in the past that if any of his team actually even mentioned the benchmark, who said, oh, hang on a minute, we've only got four percent in this and it's six percent of the benchmark, he sent them out of the room.
And that, to me, I can imagine as doing.
That exactly, and that's the perfect way to do it. It should be. You should just pick those companies that you like for whatever reason you like them, and invest more in the companies that you like more because they're cheaper, or you think they're going to grow more, whatever it might be, and ignore what everyone else is doing. That is what you want from your active fund managers. You want the ones who don't care about the benchmark. But obviously the quid pro quo of that is that those fund managers will look different from the benchmark, and that is not always going to be in a good way.
And does a high active share automatically mean that you've got a relatively small concentrated portfolio you had one hundred, If you had one hundred and fifty holdings, your active share would automatically go up, wouldn't it, By and.
Large, Yeah, the more holdings you've got, it should do. But if you had if you were a USA sorry go down, yes, down, I see what you mean. But if you're a US equity holder and you held one hundred and fifty small caps and your benchmark was the S and P five hundred, you could still have a very high active share because you're not holding in videos and the microsofts and the Google. Yeah, it's not as simple as as that. It tends to be what you're doing at the top end of what's in your market quite often. So if you take Microsoft as being I don't know, seven percent of its market currently, you can if you just buy Microsoft at four percent, you've reduced your active share by four percent against yesterday when you didn't hold it at all. So there's a bit of nuance to it, but it does. It's the best rule of thumb, or the best kind of rough guide that we have for sure.
Yeah. Okay, so we've got us more fund we've got a manager we trust, we've got a high active share. Have we got anything else?
Well, what else have you got for me? One of the things we rule out is people doing things that don't work.
Sounds obvious, right, yeah, agaven, but tell us about it.
Yeah, we don't back macro investors. So if the first thing you hear coming out of a fund manager's mouth is we're pulling out the market because we think it's going to go down, or we're going to go overweight to us because we're worried about the war in Europe, trying to guess what's going to happen in the US election. If they're positioning into industries because of their top down view, it sounds like the sort of thing that should make you a lot of money if you can get it right, but in practice, no one's ever really been able to get it right. So when you think of the greats, the Warren Buffets, the Peter Lynch's, the Anthony Bolt, what they did was to pick stocks and had different ways of doing it, but ultimately what they weren't doing is trying to guess the direction of economies or of politics or elections, or trying to spot a war coming, which nobody's ever been able to do really successful if they have for a very limited amount of time. So, yeah, you want stock because absolutely people are just assessing companies, sticking to their small part of the world that they're good at.
Okay, when I look at what you've been saying about the last time, that track has turned out to be a problem, and what turned out to be the anti tracker effectively in the following period. So domestic stocks, value stocks, small cap stocks, and we can expect that to happen again this time around. Obstuly, nothing is identical, but it seems likely that if there was going to be a rotation, it would be into those underperforming areas. So if that were the case, which fund managers. Would you think would be interesting for ordinary investors to look at the moment?
H yeah, it would be remissing me not to bang my own drum here?
Could you go for it?
Diamon?
So the reason I set up down in Fox is exactly this problem, because you've probably had the same issue. So if someone asks you, Mary, can you recommend an investment for me? I know you're a big investment trust fan, so you might say, I don't know, Scottish mortgage. That might be a one you'd pick, but you.
Would not right now, not right right now?
Yeah, okay, not right now, Okay, So pick a trust for you, recommend a trust for me now, Marin, No, I can't do that.
Because I'm not an investment professional. I'm merely Ah. You're, on the other hand, Simon, you're, on the other hand, are an investment professor.
I haven't noticed that shyness of opinion in the past, Merrion. But okay, I'll take it now. But let's say it was Scottish mortgage. The trouble is, whenever you make a recommendation like that me as a professional investor, and people do ask me for fun picks all the time. I think that could be a great fund over ten years, but it's going to be a nightmare to hold it almost It definitely will be because the greatest fund managers are so focused on their little thing they do growth value. It'll look it'll look amazing for five years, and it'll look god awful for three years, and for two years it might be somewhere about average. Over ten years, that'll make you a ton of money. But in that two to three year period when it looks awful, people are going to hate me. They're going to think, what Simon done here? Why has he told me this? Particularly if it kicks off into that period straight away.
Yea.
So the reason for me to launch down in Fox was basically to find all these active fund managers and then just to put them all in the same portfolio so that you're not just in value managers, you're not just in growth fund managers. They take the edges off each other. So in twenty twenty two, for example, we held growth fund managers and they were having a really tough time of it. We also held value managers who actually made money in that year. So we call it the heroic Journey. All of our fund managers are on the heroic journey. We can get peaks and troughs and triumphs and slayings of dragons and near death experiences, but the average investor cannot handle that. Bailey Gifford have been an amazing fundhouse. I think they're very good investors, yes, but holding a Bailey gift of fund is a very hard thing to do unless you are a professional fund manager and you've been trained for it. You know that there are cycles that funds will go up and they'll go down, and you'll be in favor and you'll be out of favor. Most people aren't trained for that. They're not ready for that, so.
It's been very uncomfortable for a lot of people.
It has been. Yeah, and you always do the worst thing. You always end up selling. You say no, lost, I've had enough of this fund. It's a give up on it and Sod's law. That's always the moment that it does really well. That is the whole point of downing Fox is for us to find these amazing fund managers, but to blend them together into such a way that actually you still get the advantages over ten years. If we hold thirty amazing fun managers, you're going to get the average of their returns, which if we do our job properly, is going to be amazing, but it's not going to be as intense as just holding one of them. There's almost a magic effect that when you put these funds together in a portfolio, they cancel each other out in terms of the wild swings, but you get left with the good stuff at the end of it. And so that recommendation having me trying to avoid giving people recommendations exactly why I launched the Downing Fox funds because it's a relatively easy thing for people to hold. It's all about the kind of user experience of holding it, which the industry, but the active industry hasn't been perhaps good enough at managing for people in the past.
So people can just go and hang around on your website and see if they can find the names of funds and have a look at how your business. That would be great.
Yeah, for sure, there are amazing funds in there. There's all sorts, and I'll get in trouble for mentioning one or two of them. I know you're a Japan fund, so I'll give you a Japan tip zena Japan. It's one fund we've held for a couple of years now. Again all that stuff about it being a small fund, intense managers, but they launched that particularly to capture that corporate governance change that's happening there.
We've had them on the podcast. Is there anyone who wants to hear more from them? Can just go back and find that episode.
What's another example of a great fund manager? Yeah, so you listen to that, listen to the Jonathan santi one and you'll get examples of the kind of managers that we think where you should have your money.
Brilliant Simon. Let me finish by taking you well outside your comfort zone. We always ask at the end of this podcast, and I can't drop it now. It's going to go on forever, however boring it gets. Weather. Okay, you've got ten years. I'm going to take away all your funds. You can't have any of your lovely active funds at all. You're only allowed to have either gold or bitcoin, and you've got to hold whichever one you choose, and you can only choose one for ten years. What's it going to be.
It's absolutely going to be gold. I do own some gold outside of my funds. We don't hold gold in the fund because it's a lump of metal and you shouldn't be paying me a management fee to hold it in a fund. You can do that yourself. The reason why I like gold is it's pretty good against light monetary debasement. It's going to be pretty good against heavy monitord's debasement, and unlike cryptocurrency, in the event of the zombie apocalypse, you're still going to be able to buy stuff with little lumps of metal that you won't be able to log onto your laptop and use cryptocurrency to buy the last bag of grain in the village. So absolutely gold.
So if you're hedging against a genuine and the world meltdown, it's got to be gold.
Cryptocurrency is zero use in that scenario.
Brilliant Simon, Thank you so much.
Pleasure, Thank you.
So John. As interesting as you hope we just get a little bored in that one.
I thought I was great. I do think to be over passive and active really interesting because good because that's a job exactly. But also you know, I agree with I think passive is like a great thing and it makes a lot of sense. I mean, I thought the distinction there that you both made about active basically requiring another step of removal from the process was actually spot on. It's like, I wouldn't recommend any of our listeners be individual stock pickups unless that's something they want to do, and I've prepared to do a lot of work. And similarly, I probably wouldn't recommend that, you know, every listener go and try and pick an active fund over a passive fund, because that also requires a bit more work. And I think that's an interesting distinction that is maybe not well. Partly lies it the part of the polarization. So it does make a lot of sense for most people, especially if they're already not really doing anything with the money.
Easy, simple, straightforward, cheap and as he says, reliable continues he said it was going to do. I mean, it's the try that mars get what you pay for, You get what you pay for. But the you know, we took a lot in this, in this conversation about active or passitive, about how they both work, et cetera. But one of the things that I find most interesting in it is the conversation about how to actually pick a reasonably good fund manager. You know, when we ten fifteen years ago when we were writing about fund managers, you could accuse them of all sorts of terrible things, you know, greed, complacency, index are getting overcharging, whatever, all sorts of things. You can still accuse a lot of the active management industry of those things, particularly of being obsessed with their benchmarks rather than with the absolute returns that like siph you and I might prefer them to be obsessed with. We're not really interested in whether a fund manager is lost less than somebody else were, instant whether they actually managed to make us more money than we had in the first place. There's sort of thing. There's lots of places where you can dive into the active sector and say, god, this is awful, But in fact there are also a lot of really great managers in the sector, and several ways, as Simon was saying, to try and figure out which ones might do well from here, because they are always going to be obviously piles underperform the index. And of course if you want to do better than a passive fund, you have to do fairly significantly better than them before charges, before you even get to what happens after charges. So there are a lot of good fund managers out there, And what I'm really interested in is the part of the conversation with Simon where we talk about how to find them.
Yeah, and I mean quotes a lot of the things that I would have.
Assumed, so.
Like the kind of the boutique kind of manager, the kind of manager that's will and they go off way, you know, a couple of million under their belt and therefore essentially not really earning a salary at all for investing, which which also I always find, I mean, I supposed to tell a frustrating thing because the smaller the fund, the harder it is to get into, particular as a retail investor, because you know, you look at all these reinvestment trusts are still in the stock exchange, and then you look at the spreads in terms of what you're you know, the gap between the buying and the selling price, and some of them are just awful. You know, you're effectively paying ten percent to get into the fund in the first place. So doing scale, ironically is a big issue there.
Well, I think the problem with new smaller funds I'm I'm interested saying. I don't know if you've noticed, but there have been a couple of shifts away from big companies recently well nowfore managers leaving and talking about setting up their own businesses. There was Ben is It More at Jupiter, and then yesterday today we heard about Peter Rutter leaving Royal London. And these are both very well established, well known fund managers saying Okay, I'm going to go set up on my own now. And when you look at that, you think, well, this is brave. This is brave because maybe they already have large amounts of committed funds behind them, but setting up, think of the regulation, think of the compliance alone. And you can't go out there charging two percent anymore if you're if you're charging over one percent, no one's going to look at you when it comes to giving you seed capital. So it's got to be a low price. Everything is expensive, and so it's a really risky thing to do, but I think it's an interesting time to do it, because I mean, Simon and I have talked about this a lot in the Partner, I've written about it a bit. When you look at the types of funds that tend to perform well, they're very often smaller funds set up by people who have successful careers behind them and they tend to do well in the first four or five years before they get particularly big.
Yeah, and I suppose there are things you've you've got that ability to be like properly active. And I guess this is the other thing that gives the selling point. I mean, one of the things that certainly to my mind has driven the private equity and private assets business in general. It's not just low interest rates a lot obviously, I think that's pushed a lot of it. There is also the rise of passive in the kind of you know, the move by the kind of asset management industry to try and differentiate itself. And so you get more of these funds that are going into these companies and then actually say taking big stakes in them and then saying, actually, we want you to do this or we want you to get better at that. And I think that's that's that's a proper differentiator from the passive funds, because you're never going to get a passive fund doing that. You might find a passive fund that can loosely give you a value strategy alow even then, I mean, one of the other main reasons I would go for active funds is simply because it's very hard to fit and nuanced strategies, you know. So like, if I want about UK value stocks, I'm probably not going to go for some kind of passive fund that pretends that that's when it does. I'd rather find a decent fund manager who knows how to tell the difference between what's actually a value stock and what's just got a low priced book ratio.
Yes, and and as soon to go bust I exactly, rather than be taken over at a huge premium by a private equity company.
Yes, so I do, I think only I think this is where you get down to the kind of brass tas of what a decent active investor does that pass It's not even so much the comparison between active versus passive. It's this is what active can do that passive just can't.
Mm hmm. That's interesting. And it is it's this this number that I think we talk about in the in the conversation active share. Every time you look at buying an active fund, go and look at the active share and if it's I can't remember what number Simon used, but I think he's me is he said ninety or but a lot of people will say eighty. But you know, if it's anywhere below seventy, this is just not worth the bother. It's too close to the benchmark to be genuinely an active fund. You know, there used to be millions of these, the closet trackers. We used to go on them, and everyone feels like they're basically gone now, but there's still out there. And even if they're not proper closet trackers as we used to describe them in the all days, they are, there's still a little too close to the benchmark for comfort. So if you're going active, just go really active.
Yeah, and then we look at the top ten Holden's and then look at the top ten holdings and the you know whatever bench market is that they fallow, and that will give you a good sense immediately it's just how active it actually is.
Yeah. Did he convince you, John you're going out to change from passive to active any of your investments?
I mean, I hate it.
I'm not that.
I didn't really need to convince it. I mean, I like, you know, I think, like I said, I've got all the time in the water pats of and I think that there's lots good uses for it. And obviously the other issue that I would probably manage more in investments much more actively if it wasn't for the job that we do, which makes it trickier to be a active minature of your own investments. But yeah, I think I think active is definitely worth way, and I think if you want to get exposure to stuff that isn't the S and P five hundred, then often active points will give you a more tailogged version of what you want than a passive fund.
Before we end, I just want to point out one more thing that Simon said at the very very end when we were talking about gold and bitcoin, and that you know, when we talk about this, everyone most people go for gold, and they say it's because they understand gold, because it's got a long history, et cetera. But Simon actually went right to the cructer of the matter and said that in the end, in the event of a zombie apocalypse, you're still going to be able to use your gold. You're not going to be able to use your laptop or your cryptocurrency. So you know, he's right if you if you're thinking about something that is there to hedge everything else, should it be something that is also as value in the event of there being no such thing as the Internet.
Yeah, I thought it was really interesting that Simon went to that so coinfidentally because he's clearly thought about gold, Because I kin I thought he's a he's a financial as it's guy, he's not going to have thought about gold. Might but he clearly actually knows his stuff about about it. So I thought that was quite interesting.
Yeah, although anyone with a zombie apocalypse on their mind, I think it might be a prepper. I'm going to call Simon and find out if he's a prepper, and if he is, I'm going to put it in the notes. I'm also going to put in the notes various links to some of the things that John and I have written on the passive Active debate over the years, as so you can have a look and have a think about it all. And one thing that we have written about recently I think is quite important at the moment as the US, in particular loser's momentum at the top and as the rally broadens out. Important possibly to be in an equal weight ETF, not a market cap weighted ETF if you're investing in the US.
Is that fair, John, I think that's fair But the one thing I would say is that is then that's an active choice.
Everything is an active choice.
That's what I mean. I mean, that's that's quite a substantial departure from the benchmark. So you're actually you get away from the transparency passive I mean, you know what it's aiming for, but you don't actually know what you're then going to get this and p FI fund could go up twenty percent, but it was all Apple on the video. I don't I actually agree that Timing wise, I would prefer an equal weight ETF, but I don't think it's that definite to go in for an active fund.
Well, I would say, if you're going to go down that road, that there literally is no such thing as a passive fun I'd like to take out the fact that I said literally because I am not a teenager. But there is no such thing as a passive fun. Do you make an active choice whatever you buy? I mean, even if you go and buy a global passive fund, you've made an active choice to own an awful lot of American technology.
Absolutely, And then that boils, don't Everyone has to be an active investorm when it comes to that asset allocation. And then it's about knowing what you want and then finding the best ways to execute on that investment. But that is then, yes, I saider, Well this is it. It's like, how do you actually debate the semantics of this? Passive is just a cheap way to get exposure to an asset class that you want exposure to.
Yes, so it's not passive. It's not passive.
Yeah, it is mis name.
Really, we're going to stop bickering. We have to stop this. Thanks for listening to this week's Merit Chalks Money. We'll be back next week in the meantime. If you like our show, rate review, and subscribe wherever you listen to podcasts and keep sending questions or comment. It's a Merit and Money at Bloomberg dot net. We read all the emails, we really do, and we're working through some of the ideas for futures, but will also start answering some of the questions in the Friday edition of John's newsletter Money to Stelt, which by the way, is ex Clinton if you haven't signed up to what you really really should. This episode was hosted by me Maren Sumset Web was produced by some Sosiety. Additional editing by Blake Maples. Special thanks to Simon, Evan Cook and John Stepfork
