Is the "star" fund manager concept still valid?

One topic of conversation that has re-appeared following the ongoing publicity surrounding Neil Woodford is the concept of the ‘star’ fund manager and whether it is still valid. This subject has been further debated with the announcement that Alex Darwall, currently at Jupiter, is in the process of setting up his own fund management firm. Much of this is linked to the current popularity of passive investing which, by definition, will never have ‘star’ managers, but it is also linked to the debate around fund costs and whether active management, in itself, is worth paying for, i.e. does it provide value for money, particularly in equities?

Fund performance drivers

At RSMR, one of the key factors within our qualitative research process is to identify what the main drivers of a fund’s performance have been and what they are likely to be in the future, including the fund manager/fund management team and the resources at their disposal. A ‘star’ manager may have access to a large research resource within their firm; for example, Alex Wright at Fidelity. Another may have a very defined investment process that does not require a large research resource; for example, Terry Smith at Fundsmith, whilst others rely heavily on their own/team’s research such as Alex Darwall. In addition, some asset classes are naturally much more research intensive than others, e.g. UK small caps versus UK large caps, and they require greater resource. It is the job of the RSMR investment team to identify the appropriateness and quality of the fund management team structure in each case, whether this relates to ‘star’ manager or otherwise.

The average manager and the relevant index

Whilst this is important, those fund managers/management teams operate with a stated investment process and it is fund performance that represents the application of that process. This is where the ‘passive-ists’ draw their arguments from as it is true that, in some cases, the average active equity manager underperforms a representative index over the medium to long-term (see table below). This certainly seems true when looking at US equity funds and explains the large use of passive investments in this space. The argument is more nuanced when looking at UK and European funds as the differences between the average manager and the relevant index are much smaller (as expressed in the table below). In addition, our research process is not aiming to select the ‘average’ manager and we would expect that our hit rate for outperformance from RSMR-rated fund managers within these sectors to be much higher than 50%.

 (Source: Morningstar Direct, to end June 2019)

It is also true that funds/managers suffer periods of underperformance and this can last for some time, especially if their investment style is out of favour.  This is particularly prevalent at the moment in UK equities with some very highly regarded, value-orientated fund managers/management teams struggling to outperform their peers, e.g. the Value team at Schroders, Ben Whitmore at Jupiter, Hugh Sergeant at River & Mercantile. This does not make them bad managers and does not spell the end of the ‘star manager’ (the popularity of Terry Smith and Nick Train are testimony to this), it just means that the current conditions are not conducive to them outperforming.

A day in the sun

These value managers will have their day in the sun and outperform their growth counterparts, we just don’t know when that will be and how long it will last. Value funds have seen periods of outperformance in the last couple of years, but these have been very short-lived.  From a portfolio construction perspective, particularly given the level of outperformance from growth over value in recent years, having some exposure to the value investment style should be beneficial for performance over the next few years, whether that is through a fund with a ‘star’ manager or otherwise.