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Talking about tenure

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17 January 2020

David Prosser highlights long-serving managers as one of the reasons that closed-ended funds outperform their open-ended counterparts.

One noticeable trend of 2019 amongst investment companies was for boards to take a more ruthless approach to hiring and firing fund managers; a string of managers moved on as directors sought to reinvigorate performance. But while we should welcome evidence that independent boards are prepared to flex their muscles on behalf of shareholders, it’s also worth noting new research from Morningstar. It suggests one reason investment companies tend to outperform other funds is that they keep hold of their managers for longer.

Morningstar looked at the performance of both investment companies and open-ended funds in the UK Equity Income sector, concluding that over the past decade, the former have outperformed the latter by an average of 1.5 percentage points a year. The gap over the past five years has averaged 0.8 percentage points. In addition, Morningstar also compared manager tenure. The typical UK Equity Income investment company manager has been in post for 12.8 years, it says, while the figure in the open-ended sector is only 6.9 years.

Now, Morningstar freely admits that this gap is not the only reason investment companies have outperformed. Factors such as lower charges and investment companies’ ability to take on gearing, so valuable in a bull market, will have come into play too. Nevertheless, the long-term view and considered investment process of a firmly established investment company management team will undoubtedly have been important.

No fewer than five UK Equity Income investment companies have managers who have now been in post for more than two decades, led by James Henderson at Lowland, who took up the reins in 1990. He’s delivered annualised returns of 12.2% over the past decade.

By contrast, only three comparable open-ended funds have managers with a track record going back more than 10 years – and none match the performance of their investment company counterparts. Francis Brooke of Trojan Income leads the pack with 15.3 years of service under his belt, delivering a 10-year annualised return of 9.8%,

What is the link between tenure and performance? Well, in part, there’s an element of inevitability here – managers with the strongest returns are naturally more likely to stay in post for longer, so the prophecy becomes self-fulfilling. Still, there are good reasons to seek out long-serving managers. Morningstar argues: “Managers who have run the same fund for a long period of time are more embedded within the investment team, know the fund and the companies it invests in better, are familiar with their analysts and know how to use the resources at their firm, which can vary dramatically between investment houses.”

This is why manager tenure is one important selection criterion that most analysts and ratings agencies use when recommending funds. They tend to score funds with long-serving managers more highly – and are reluctant to recommend funds where a manager has recently departed, even if their replacement has a good track record elsewhere.

One interesting question is why investment companies tend to keep their managers for longer. It’s difficult to say definitively, but the culture of the investment company industry, focused on long-termism, stability and good governance, is an important part of the answer.

The bottom line is that investors should naturally be attracted to managers who consistently do their jobs well over an extended period. In investment, where the market cycle ebbs and flows, bringing different conditions over time, experience really does matter. In this regard, while it’s encouraging to see that investment company boards are now far less likely to be patient with under-performing managers, the longer tenure of managers in the sector is also an important selling point.