ADVANTAGES OF A SMALLER FUND SIZE / AND THE BOOMING LIC IPO PIPELINE.

Within the active v passive investing debate I think it sometimes focuses too heavily on active managers with large portfolios. I shall explore why active management can make sense with smaller portfolios.

It has been a while since I have thrown in a typical Warren Buffett clickbait quote so here goes…

“If I was running $1 million today, or $10 million for that matter, I’d be fully invested. Anyone who says that size does not hurt investment performance is selling. The highest rates of return I’ve ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It’s a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.”

This quote was mentioned in the following link that I thought was a good short summary on the topic.

http://basehitinvesting.com/how-buffett-made-50-per-year/

I will now continue on the topic with the help of some other articles I enjoyed reading. These articles below also discuss the advantages of running a smaller portfolio size.

https://theconstantinvestor.com/big-versus-small/

https://www.livewiremarkets.com/wires/3-ways-you-can-beat-the-fundies-2018-07-27

https://www.livewiremarkets.com/wires/6-more-pieces-of-advice-rarely-given-to-private-investors-and-smsfs

 

LIC IPO pipeline, should we then tread carefully with fund managers becoming larger?

It is not uncommon to see LIC IPOs launch by boasting a historical performance record achieved with far less in AUMs. When reading the prospectus, I would pay attention to the historical AUMs they had using the same strategy that the proposed LIC is for. Will the money raised for the LIC, together with any other growth in funds for this strategy, make things more difficult?

Also show caution when the manager’s performance record contained in the prospectus is over a relatively short time period, or involves a different style of mandate. Has their performance record stood up through different market cycles and with a similar amount of AUMs?

Some of the more recent newcomers or planned IPOs in the LIC space such as L1 Capital, Tribeca & Firetrail shall be interesting to observe in this context. L1 Capital chalked up great performance in their unlisted long / short product. As a result of this organic growth and then the LIC IPO being so large, they now have plenty more assets to manage this way. Tribeca got out of the blocks in sensational form with their unlisted global natural resources strategy product. If they are successful in raising the maximum amount for their LIC though, this strategy will now be managing significantly more. The targeted size for the Firetrail Investments LIC doesn’t seem unreasonably large given their strategy. Bear in mind though they have been aggressive in chasing institutional funding outside of this LIC that could see them managing a lot more.

I also read in the news that Hyperion Asset Management are considering launching a global LIC based off their unlisted strategy. These examples are relying on relatively short performance records, when considering the specific strategy proposed for the LICs.

 

Another way to take exposure to growing fund managers.

If you find yourself easily falling in love with the sales pitches of the above floats, don’t forget about FGX. Note all my disclaimers about not giving financial advice, and that I still own some FGX myself. At least I know the fee drag here is about 1% max. It is comforting to know if their selection of managers produce about 10% per annum at the gross level I should get about 9%. Some of the more recent hedge fund style LICs can even charge 20% of any positive return as a performance fee. Throw in large base fees and all the admin costs, suddenly that 10% per annum at the gross level gets watered down. Don’t be surprised if at the shareholder return level you only get about half of that. That assumes you are lucky picking one that doesn’t trade at a large discount to NTA in the future.

Looking at the FGX report for August I see about 53% of the portfolio dedicated to absolute bias / market neutral strategies. As it so happens I see names such as L1 Capital, Tribeca & Firetrail amongst their managers. The FGX board can give some ongoing thought as to the fund sizes of their selected funds. If they feel some may be facing capacity issues they could adjust exposures accordingly if necessary. I am guessing smaller up and coming managers may be around that would be happy to be part of this Future Gen structure. Don’t expect certain retail stock brokers to tell you this though. There are no substantial fees for them to direct you towards FGX in the secondary market.

I must clarify that FGX has generally traded at a small premium to NTA in recent history and I have personally not bought LICs at premiums. I am still holding mine though from the past and will likely to continue to do so for years to come. I am more trying to illustrate the point that even a small premium may not be silly here versus picking up a new LIC at NTA in the float. If one has a fee drag of about 1% versus the other 4-5% (potentially more if they perform better), it makes you wonder.

 

Should I bother trying to actively manage my portfolio?

So you may occasionally come across some of my weirder stock picks around this blog and wonder what on earth I am trying to do. If so please keep the 4 linked articles above in mind. You probably think why don’t I just get a life and simply buy a cheap ETF on the S&P500. Well I hope those earlier articles partially explain why I try and bother with some active stock picking. Whether it has proved worthwhile for me is another question!

For those that don’t have a lot of time on your hands, and don’t find investing extremely interesting, ETFs are more appealing. However if you are a smaller private investor and fascinated by the investing game, I don’t think you are crazy for trying an active approach. Or maybe I am just trying to convince myself I am not crazy!

While the 2018 investing year has been a bit mixed for me thus far, the last few months has seen some better performers. They have come from stocks that the average fund manager would be too large to get involved with. In fact, I can think of at least 5 that would often go many days with no trades at all. They trade “by appointment” as some may say. I’ve also found it handy when certain corporate actions favour the small investor.

Before you go and rush out and punt on illiquid stocks though, note I still have had my fair share of duds. When things go bad for a stock then the lack of liquidity is not fun!

So in conclusion I am going into bat for the benefits of active management in some cases. I speak in terms of some private investors, or fund managers where AUMs are still relatively small, and their fee structure makes sense. Once you get into the darker side of aggressive base and performance fees, funds heavy into marketing their surging AUMs though it may pay to be cautious. This is especially the case if you are a time poor investor who won’t get around to analysing the performance record and fee structures of the manager. Passive strategies may be far more suitable. When it comes to stock picking I also think you have to be prepared to devote a lot of time if you want to DIY. If it still tempts you I think your chances are better at the smaller company end. Don’t bother letting your research compete with the full time analysts by making calls on whether CBA will outperform NAB over the next 12 months or not.

 

14 thoughts on “ADVANTAGES OF A SMALLER FUND SIZE / AND THE BOOMING LIC IPO PIPELINE.”

  1. As a side note to the FGX/FGG discussion it is worth noting how the overall fund manager has moved around fund allocationsover time eg increasing the percentage of market neutral compared to long position funds. Assumably this is for more protection in caseof a market downturn. Additionally the did move down Antipodes Partner exposure about 12 months ago when they realised that there was an asian over representation. In a sense then, both vehicles enable a rebalancing of asset type and/or geographical exposure etc. without the need to rebalance one’s entire portfolio. I think that tnis is a great advantage with them and I am considering buying at least FGG. It appears to be a “steady as she goes” performer but with perceivably lower volatility.

    1. I certainly agree the Future Gen funds will continue to provide a steadier ride. The fact that they have more or less kept pace with indices in the bull market is a solid result. Over a cycle I expect it to be evident they have clearly added alpha and with lower volatility.

      As more new LICs come out it tends to highlight that on a relative basis how well the Future Gen Funds are structured.

      Another side note is I just read of potential new LIC where comparisons are being made to the Future Gen Funds due to the charitable aspect.

      https://www.afr.com/street-talk/hamish-douglass-lowys-solly-lew-back-new-listed-fund-20180925-h15u85

      It’s a bit early and light on details to comment too much on right now. The stock picks from this investment conference are getting a big following though in recent times so that may assist.

      1. Just adding this link for information purposes only about this Hearts & Minds Investments LIC, not a recommendation.

        https://cuffelinks.com.au/message-hm1-investing-hearts-minds/

        I won’t be investing in the IPO. If the fund happens to get off to a slow start and it traded at a decent discount, I would give it some thought though. That could be a long way away or simply never happen, we shall see.

        Investors seem to be getting more picky now with LIC IPOs with news of the Firetrail LIC not progressing.

        https://www.afr.com/business/banking-and-finance/pinnaclebacked-firetrail-shelves-listed-investment-company-20181015-h16osp

      2. I have made a few comments about the Hearts and Minds LIC in a different area on the blog in case anyone is interested. I thought I would keep a separate area more to discuss current opportunities and offerings in the market over here.

        https://valueinvestingforaliving.com/2016/10/21/where-institutions-avoid-and-retail-investors-find-boring/comment-page-1/#comment-758

        Feel free to discuss there in the comments thread if about the Hearts and Minds LIC or any other current opportunities.

  2. Fascinating article Steve, thank you 🙂

    If i read you correctly FGX can be invested in a fund that traditionally charges say 1+15 or 2+20 but FGX gets the raw returns without the fees ?

    Or is it that when you for an example say that if FGX makes 10 it gives you 9, is that 10 already post the fees of the underlying manager ?

    I’m not clear …

    1. Thanks Peter,
      Your first comment is a good way to think about it (but keep reading my comments about the donations), whereas as your second comment I think is incorrect. Yes FGX gets the raw returns and incurs no fees from the fund manager because they are offering their services for free. But then you need to keep in mind that FGX then takes out 1% and gives that straight to charity. I hope that makes sense! Other LICs can also regularly have other costs such as admin, tax, accounting / auditing, custody, registry, directors’ fees etc and in some cases this can add around a 1% (but varies a lot with each LIC). In the case of FGX these additional costs are close to zero (I would have to check exactly), because many of these service providers also cover these for free for the sake of charity, and any fixed costs are small because of the large fund size anyway.
      Same deal for FGG. Only reason I focused on FGX in this piece is I thought it was interesting that they already invested in some of the managers launching LICs at the moment.
      If I haven’t explained it well there is always the Future Gen website that has a heap of info. So hopefully between my comments above and the website that can give some clarification.
      Cheers
      Steve.

  3. Thanks for your prompt reply Steve, this really is a great blog.

    Readers can see that i’m one of the people you sometimes mention, an investor who doesnt carefully do all his homework.

    In this case, its a rare POSITIVE surprise when belatedly one does one’s homework.

    It really rams home your point that whilst you aren’t giving advice the FGG FGX vehicles are very good or fair – at a minimum compared to what else is available, (plus your point that individual retail investors don’t always do enough reading before acting.)

    I’ve also found them to be very well administered, with good care for the retail investor, and it is a chuffing to be able to allocate which of the charities you like each dividend time if you feel like it.

    from
    http://futuregeninvest.com.au/lic/future-generation-global-investment-company/
    2.12. Fund Manager Capacity and forgone Management and Performance Fees
    The Initial Fund Managers have committed to allocate a portion of their investment capacity to the Company and they
    have also agreed to forgo all Management and Performance Fees on that commitment.
    with more in 2.13, 2.19, and 2.10

    Its all there if you look …i’ve learnt one or more good lessons from your blog today 🙂

  4. Smaller boutique fund managers are more likely to have decent skin in the game and conviction to stock picks might hence be expected to be higher, The weakness is, of course, key man vulnerability so you need to weigh these two up. My main concern for LIC/LITs of the smaller market cap variety is the level of liquidity especially in times of market stress.

    1. I am impressed by their decision not to go through with the LIC. Most LICs in this situation just hope they fluke a good start, and then hit investors with more share issuance to grow up to their desired size.

  5. I agree. I think that they have a lot on their plate given the size of their existing funds and low liquidity with a new LIC is not what they need for a new but experienced fund manager

  6. Steve Green !
    you’ve picked this size of fund issue like a nose 🙂

    just one e.g. ( i think you also called right )

    LSF
    -30% from IPO today !

    And lonsec says no longer to be held, too big

    Great little chapter in your blog.

    1. Despite a discount opening up for LSF, I suspect it still may be quite a while before it turns around. Not only size but the fee structure seems like a big handicap to me, and I worry the successful marketing of the IPO seduced investors with limited experience. Investors that could still reach capitulation stage in the future.

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