It is one thing to read about panics and crashes in a textbook, but quite another to experience them first-hand with real client money at stake.
But even so-called 'star' fund managers, including those who have been around a long time, aren’t necessarily the long-term solution. Stars can lose their shine or burn out altogether.
So rather than looking at recent performance, a much better starting point is to look for managers with a sensible investment philosophy and robust process that have been tested over multiple market cycles.
Rather than trying to pick the next star, look for those who have a deep bench of proven investment decision-makers. That list isn’t very long.
The next step is to dig deeper and understand the manager’s incentives and the degree to which they have aligned their interests with those of their clients.
Is the firm owner-managed or does it have external shareholders who will put short-term pressure on the investment team? Do they “eat their own cooking” by investing substantial personal wealth in their own funds?
Is the business incentivised to focus on investment performance or on marketing and growing the size of the firm?
The list of firms that can tick all those boxes is even smaller.
Active or passive?
Of course, one could simply ignore all of this and opt for a passive approach.
In the interest of full disclosure, at Orbis we are firm believers in the value of active stockpicking. Even so, we recognise that a passive strategy can indeed be the right approach for many investors.
The key advantage is that it guarantees market-like returns while minimising the drag from fees and expenses — and this alone is enough to beat the vast majority of active managers (but not all).
However, passive investors also need to be clear about the risks, and these are not often highlighted by passive’s evangelists.
In our view, the inherent flaw in a passive strategy is that it will tend to be overweight expensive securities and underweight cheap ones. This gap can become increasingly pronounced as markets rise and more money flows into passive funds.
That’s particularly dangerous at times like these when many market players appear to be following a momentum strategy and buying companies simply because their share price has recently been going up.
Some may be doing so as an active bet on continued momentum, and that is not an irrational strategy for a handful of savvy traders who can do it well, but our guess is that most others have unknowingly become momentum investors by blindly pouring money into passive strategies.
