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.
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.
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.
Is there a conflict of interest with such large ASX LIC IPOs?
The LIC sector at least seems to be improving in terms of the structure of some IPOs these days without the hefty commission drag up front, and not using “free” 1-1 options. Just take with a grain of salt though when some fund managers say the IPO is all about making their expert strategy more accessible to the public. Deep down they are probably fully aware of the Warren Buffett quote I noted earlier. The weight of money may well significantly handicap their return prospects going forward. However if they lock in hefty base fees for the next decade, and performance fees off very low hurdles, well one party may come out very well 10 years from now. Unfortunately that may not necessarily be the small investor!
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.
Future Generation Investment Company Limited (ASX: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.