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Volatility of UK share prices in 2011


Daily % change in the FTSE 100 index


2.5 2.0 1.5 1.0 0.5 0.0


and fear on a weekly – if not daily – basis. Such an environment is difficult, to put it mildly, for active portfolio managers. A decision to buy or sell that’s wrong by one day can make an enormous difference to performance, and the temptation is to trade more often in an attempt to keep up with the news. In these conditions, active managers as a whole often do badly because of the trading costs they incur, and results are more random than usual. This means those who employ active


managers – individual investors in mutual funds, trustees, pension plans – will face a dilemma when they come to review performance for 2011. It is highly likely that some previously reliable managers will report very poor results, and that some thought to be average will have done relatively well.


What to do? A commonly seen reflex action for investors is simply to switch money from poorly performing to better performing managers, though this often proves expensive for at least four reasons:


1. It doesn’t take account of the risk profile of the fund (managers who take fewer risks tend to outperform in down markets but can lag up markets);


The economic outlook for Europe depends on political decisions that can’t be predicted with confidence


2. It doesn’t take account of the style of the fund (a switch between, say, a large-cap manager and a mid-cap manager is a fundamental change in investment strategy that should not be undertaken lightly);


3. It doesn’t take account of the fact that managers with good performance can be overwhelmed with inflows to their fund. The greater the size of a fund, the greater the number of successful ideas needed to achieve a given level of performance. Star managers frequently complain that their investment performance has deteriorated as a result of their commercial success;


4. Fund-management firms monitor their fund managers’ performance continuously, and change processes and personnel in an effort to make improvements. These changes tend to be made after, not before, a period of poor performance.


While proper analysis of performance statistics can prevent the first two mistakes (the Morningstar system allows for risk, for example) they can’t prevent the last two. The most effective approach is to make


an informed assessment of the way a particular fund is managed. This means understanding a firm’s investment philosophy: how it finds investment opportunities; its process of turning good ideas into investment decisions; its risk management and portfolio construction technology; and its people. This sort of dialogue with fund managers


is not normally available to end investors, even to large pension schemes, so employ a skilled adviser – an investment consultant, for example, or the relevant department of a private bank. While such managers do not always pick winners, they are good at weeding out the persistently poor performers. n


TOM HILL is CEO at UBS Jersey February/March 2012 businesslife.co 37


15 december 2010 12 january 2011 9 february 2011 9 march 2011 6 april 2011 4 may 2011 1 june 2011 29 june 2011 27 july 2011 24 august 2011 21 september 2011 19 october 2011 16 november 2011 14 december 2011


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