How to choose a good fund manager

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Always a danger in thinking this time is different. I guess investment time frame is an important consideration but switching/adjusting to perhaps temporary perceived changes in the investment landscape is difficult and likely error prone. How often do we and the so called experts get it completely wrong!? Just like market timing, impossible to get right most of the time.

Warren Buffet has probably seen it all over his long investing career. A very successful active investor with great acumen, skill, luck and gut instinct. Oft quoted by fund managers seeking success by association, yet rarely emulated.

Some of his sage advice, that I'm sure still stands (i.e. I'm sure he doesn't recommend abandoning what he's long said and go invest in managed funds!):

- He strongly recommends low-cost index funds for the majority of investors, suggesting they offer a simple and effective way to achieve long-term investment success. He believes that most investors struggle to consistently outperform the market, making index funds a practical choice for building wealth.
- He famously instructed the trustees of his estate to invest 90% of his wife's inheritance in a low-cost S&P 500 index fund, demonstrating his personal conviction.
- Buffett's advice for the average investor is to invest in a low-cost index fund and hold it for the long term.
- He emphasizes the importance of choosing low-cost index funds, highlighting that these funds can deliver better returns due to lower fees.
- Buffett has stated that index funds can allow investors who are not experts to outperform most investment professionals!

And in my view - arguably the really big question - in a multi-asset well diversified portfolio - will active portfolio construction/asset allocation make up for the likelihood of selecting underperforming active asset managers/funds - in Australian, US etc globally - over the long term (10-15 years +)?

Hi James,

one thing you have not mentioned is the NTA discount of many LICs and REITs.

To explain you must first define what you mean by "performance". Do you mean fund entry/exit price plus dividends or do you mean NTA growth plus dividends - internal performance. The first depends on invester perceptions (and indirectly marketing and investor relations) and the second depends on actual performance of those responsible for investing capital. A third wrinkle is franking credits and investment turnover (by manager).

When I buy a LIC (or REIT) I consider it bought for a 10 year time horizon. In practice most LICs have events that shoten the actual holding time, e.g. windup, take over, change in investment team. So if I buy at say a 20 or 30% NTA discount then there is room for small underperformance of the investment team. I am not saying buy any LIC because a lot of them have investment teams that have proven themselves very poor investors. This is also a reason to bail out of long held managers when the investment teams makes silly mistakes.

The investment turnover by investment managers has an interesting effect on the perceived performance of LICs (and other investment companies). Those with low turnover (e.g. AFI and other older LICs) do not generate as many franking credits from capital gains and so pay lower dividends. This means their share price has a natural growth higher than the LICs that trade more often. Higher growth in capital means lower dividends even though total return between the two is similar. The advantage of the higher turnover managers is that they give more franking to investors, whereas the lower turnover companies save it up for future investors. What will happen if the goverment lowers tax rate on companies? The answer is that the capital gains tax payable with be at the new rate, therefore the franking credit disappears. In practice the government will (hopefully) give some notice to the companies concerned so they can rearrange there affairs to give their shareholder som benefit. You can see what happend back in about 2000 - the last time the goverment lowered company tax (lots of special dividends).

Anway, you can see I am in favour of investing in LICs and REITs over ETFs. However, you can sometimes find it difficult to find an appropriate LIC for what you would like to invest in so I do invest in ETFs. For example, 15 or so years ago there were no LICs trading at a large discount that invested in Australian shares so I invested in VAS. Today, there are no LICs that invest in high quality credit (AAA) and no LICs that invest in high quality mining/drilling companies (BHP, RIO, Woodside, etc) so ETFs are the only choice. (personal evaluation of course)

Anyway, I think you may be refering to unlisted managed funds so the above may be of low relevance. Personally, I prefer the enforced transparency of listed funds as I cannot find enough independant information for unlisted funds. After seeing how listed funds cherry pick and exagerate their performance even though the historic data is published by the ASX I find it hard to beleive most unlisted managers.

Thanks for writing on this subject, there is very little considered work published.

Hi No,

Yes, this article referenced unlisted managed funds rather than LICs.

Much of what you say about LICs and buying them at discounts makes sense, as does your points about some of the limitations on ETFs.

Thanks,
James

One thing is true. This time (in history) is different. Not the here and now, but the use of technology. Index funds are just a small number of the available ETF's, there are many newer ones which use the same sort of research that active managers use for differentiation. Examples include the use of quality screening, equal weighting etc. So the bog standard cap weighted index is not the only game in town for the users of ETF's. Ok the hype may be a bit overdone, but as good AI comes into play more and identifies other factors that either increase performance, or at the least, remove duds it will be even harder for active managers. The last bit is even if you do find one (in advance) who is good, would you put 100% of your funds with them? Probably not (no advisor who wants to keep their accreditation would suggest that). So now you need to identify not one but say five outperforming managers. The odds of that get exponentially slimmer the more you add, and the underperformers will just drag down the over-achievers. The only possible winners might be micro and small caps where the information is much less voluminous, and if you have a particular insight into a specific industry. Then you have the key person risk all over again.

Steve,

You make good points. I'm just probably not quite as negative on active funds as you are.

James

Dear James,
I'm a retired financial planner.
As you and I know, there are around 7 major investment processes, from Value v growth, top-down v bottom - up, Thematic, index funds etc. with a number of sub-sections like smaller companies, Australian v International.

In my opinion, trying to pick which investment structure to be in, requires a timing issue that I was never sure if anyone got the timing right for getting into one investment arena and the right time to get out.

I took the view like you that I looked at what and where the fund manager invested but more importantly, whether the guy running the fund and his analysts were similarly invested in the fund like our clients.
I was convinced of two things.
First off, no fund manager got it right 100.0% of the time.
My favourite questions over 40 years were,
1. Tell me what you got things wrong?
2. Tell me what you learnt from it?
3. And would you do it again?

In over 40 years in the profession, not one fund manager ever failed to answer those questions honestly!
Secondly, I was convinced that fund managers with "skin in the game" didn't want to lose their money any more than my clients or myself.

I have never been a fan of indexed funds.

I think you get what the market gives you,....at a low cost.
It reminds me of someone in a car with their foot on the accelerated going uphill but when going downhill, you find, the car has no brakes!
Unfortunately, many active managers mirror the performance of indexed funds, albeit at a larger cost which makes low fee index funds appear to be an attractive proposition.

I also agree that fund size is a problem, and large funds find it difficult to change direction without effecting the market value of their investments.
And the obvious point that I used to make is; it was like waterskiing behind the QE2.
By the time you changed direction, you either drowned or was eaten by sharks.
Not a desirable outcome, either way.

Allan,

A different perspective, thanks.

Giving honest answers is good to hear, but the data says most of these managers still didn't outperform. There is a problem about forecasting, its particularly difficult with the future. An issue is skewness, where just a handful of companies make the vast bulk of the returns in the sharemarket. There are many dud companies, some who were good but fell off the perch (eg Kodak) and others that just struggle through every day. Now the problem with skewness is the handful of companies that deliver the goods are often not known in advance, and if you don't hold positions in them, you underperform the index. However the index, by definition holds each and every winner, who do enough to make up for the losers with some profit. That is why the index is hard to beat - when its obvious who the winners are the index has already got a head start on you.

What about in the case of specifically wanting an ethical alignment with one's investments (and i mean through a transparent process, not just through label/branding)? The options for low cost etfs are limited in this space, forcing investors towards active fund managers/SMAs, in order for some diversification.

Whilst paying for their advocacy is ok by me, and good returns are sought (though it's hard to get the right benchmark to measure against), it's difficult to find good options. Performing funds without fees that are so high.
Any tips or thoughts in these areas?
And, is anyone aware if whether some of the longer term better performing funds noted in the comments above have ethical tints?

'ethical' what an interesting word - people with needs and wants are dependent on most businesses or services in some direct or indirect way...
hence... earning an income with money and return on investment off the pain and suffering of others - Health Industry is one such example... something to ponder...

Little different but would you consider Soul Patts an active fund manager to choose from?

Reg,

It is to a degree, albeit with a different structure. I would call it an investment company, in the mold of Berkshire Hathaway.

I think Neil Woodford thought he was the lead guitarist in the band and set out on his own.Apparently it was the rhythm section ( bass and drums ) doing all of the work and he eventually cost people a lot of money.Another one that may be doing that ,probably best not to name him,has stumbled in the last 5 years.He has the yacht and the tropical island hideaway,he stumbled after 9 years or so.Finding info on him is difficult now,but I may be looking in the wrong place.

Peter Thornhill might know of Scottish mortgage trust (SMT) as he likes City of London.They stumbled in the last 5 years but seem to be coming back and have a good 20 year record. I prefer to do my own thing,happy to be the rhythm section and let the people on lead pull all the faces and grimaces.

As you say SPIVA give ~ 85% underperform and ~15 % do reasonably,I think they give info on 8 or 9 countries .Most of the time I forget to look at that ( as in 99% of the time).Something jogs the memory and I remember to look

Thanks for the article James. Here is an example of a fund that has consistently stayed on top for >10 years and why we should always combine passive investing with excellent active fund management:

Australian Shares 1
Annualised Return: 9%
Volatility: 14%
Sharpe Ratio: 0.49

US Shares 2
Annualised Return: 16%
Volatility: 13%
Sharpe Ratio: 1.08

Global Shares 3
Annualised Return: 13%
Volatility: 11%
Sharpe Ratio: 1.00

Global Value Fund (ASX: GVF) 4
Annualised Return: 11%
Volatility: 7.6%
Sharpe Ratio: 1.22

Unless otherwise stated, data sourced from Bloomberg LP, Staude Capital Limited and Company reports and all data as of 31st March 2025.
1Australian shares refers to the iShares Core S&P/ASX 200 ETF gross return in AUD with management fees of 0.05%
2 US shares refers to the iShares S&P 500 ETF gross return in AUD with management fees of 0.04%
3 Global shares refers to the iShares MSCI ACWI ETF gross return in AUD with management fees of 0.32%
4 All data presented on GVF is after taxes paid, expenses, management fees, dividends paid and the impact of dilution from exercised company options

Taking a punt on a fund manager is similar to taking a punt on a company. But companies have more info available, & are subject to more detailed reporting rules.
It comes down to trusting a manager, in either case, and it is hard to get info on this.
Diversification is not a reason either, as most funds, apart from ETF, require $20K or more to start.

Eley Griffiths have been very good for a long time.

Forager Managed Funds is an excellent example of first choice with a track record of 15 years.
Having exceptional transparency with mostly updates and quarterly webinars and annual roadshow - all abut connectedness with the unit holders - all 2,000...
More so, run a lean business with low analyst ratio - Australian 3 analysts, International 4 analysts.
All adhering to a discipline regime of stock selection and investment processes that often takes weeks to months before executing the final buy process.
Finally, all analysts are heavily and some fully invested in the Funds under Management, directly aligned to the unit-holders.
Truely, one of a kind fund manager!

Agree.

I invest with them and the Aussie funds has done well but the international has typically been below its benchmark…hopefully it improves

Dauf,

Personally, I think the international fund has done relatively well given its value focus.

James

I would like to add one more disadvantage of using active managers. That is the tax payable by the investor. The manager is not interested in after tax performance being solely judged (and remunerated) on pre tax returns. So they happily churn portfolios. your end of year tax statement shows the shocks. A lot of short term undiscounted capital gains.

A low churn passive fund gives a much better tax outcome. 

I have a different view on that.

Being "active" doesn't mean the manager does a lot of churning of the portfolio. That observation confuses active management with trading. Some active managers do a lot of trading, but that depends on their process.

Active really just means that they invest in a portfolio that doesn't align with their benchmark - e.g. the ASX All Ords, ASX300 or ASX200. Most active managers set a portfolio which is overweight to some stocks and underweight to others, then hold those relative positions for considerable periods of time.

Which means that there aren't lot of realised gains or losses in the distributable income they pay.

Furthermore, if you believe active management can add value - even if it's a trading style of investment process - then surely the capital value changes that are sold out will mostly be realising gains, not losses. In that case, so what if that results in the need to pay some tax - you are still going to be ahead of the passive return.

So this point isn't ''one more disadvantage" of using active managers at all.

My 2 cents worth on good active Australian equity managers. I've been investing with Ausbil (Paul Xirades and team) for many years now. They generate around 2.5% pa better than the market return over the medium term to long term very consistently, without ever being too far below benchmark when things go against them.

What’s “ the market return” ?

Ausbil Active Dividend Income Fund
https://digital.feprecisionplus.com/documents/ausbil-fc/en-au/PLJ2/FS

Excess Return Since inception July 2018 -0.02%. Negative over past 5 years.

'Ausbil to launch Active Dividend Income ETF in 2025
Ausbil Investment Management (Ausbil) is pleased to announce plans to introduce its first exchange-
traded Fund (ETF) for its Active Dividend Income strategy in the first half of 2025.' (Not yet)

Dudley, the objective of that fund is expressed in relation to tax effective income, not outperforming on a total return basis. Being 2 basis points from index return is in line with that.

The fund I invest in has done exactly what I said in my comment. If you think your selective data choice contradicts me then you need to think again.

"The fund I invest in": fund not mentioned, so I looked for what might be popular.

John, 'the market return' is the benchmark for the fund, so the ASX 200 or 300 or All Ords usually.

Dudley - really? Thought you'd be more meticulous than that and choose perhaps the first fund that comes up on their own website, the one with the actual long term track record (back to 1997) and the greatest amount of funds invested in it ($1.8 bn), rather than one that's well down the list and only launched a few years ago. Had you done that you'd have thought twice before attempting to contradict me and naysay my comment.

"the one with the actual long term track record (back to 1997) and the greatest amount of funds invested in it ($1.8 bn)":

Ta, that uniquely identifies the one you were 'crowing' about:

"They generate around 2.5% pa better than the market return over the medium term to long term very consistently, without ever being too far below benchmark when things go against them.":

https://www.ausbil.com.au/products/australian-equities/ausbil-australian-active-equity-fund
Inception Date: 31/07/1997
Entry Price: $4.1654 (as at 01/05/2025)
Exit Price: $4.1488 (as at 01/05/2025)
Currency: AUD
Fund Size: A$1,798,452,789.89 (as of 31/03/2025)
APIR Code: AAP0103AU
Bloomberg: AUSITAA AU Equity
mFund: AXW01

https://www.ausbil.com.au/CMSPages/GetFile.aspx?guid=2c23cc11-50cd-410c-a93b-c701ce54752c
Performance since inception pa Date: July 1997 1.62%.

Skill or luck:
1. How to tell from the fund unit price series compared to the Benchmark S&P/ASX 300 Accumulation Index 'price' series?
2. How to tell from the past if similar performance will persist?
3. Is the risk of adding an intermediary worth it?
Many ask, none(?) definitively answer.

Thanks James, that is an excellent article. It addresses the second of the two step process.
1. Can any specific manager beat the market - yes, because:
a) some businesses are better than others (eg a better Industry or having better Management)
b) it is possible to predict some of these businesses.
2. Can we find such Managers - your points are good; but I would highlight that the main focus is their philosophy and their skills at analysing businesses (stocks).

Hi James, do you have some examples of consistent outperformers in the ASX space?

Hi Burrow,

Off the top of my mind and not an exhaustive list - Auscap, Hyperion, Greencape, Mirrabooka, Glenmore, Sandon, Spheria, 1851, First Sentier, Fidelity, Airlie, WAM select funds.

I've missed out many and these aren't recommendations - DYOR.

James

I'd add Allan Gray, Smallco, Level 18.

I think I'll buy some more Pinnacle :)

"... if you think you have the skill to identify a good active manager that will perform AFTER you invest..." then why not identify good companies and invest directly (with zero fees) instead?

Because they are very different skillsets.

Hi James,

As someone who came from the active world but now runs a fully indexed investment business (Stockspot), I wanted to directly respond to the three points you raised about why investors should bother with active funds.

1. The tide might be turning

This is a familiar narrative. Whenever markets get volatile, active managers start talking about how it’s a “stock picker’s market” again. They’ll say dispersion is rising, index composition is shifting, and opportunities are everywhere.

It always sounds compelling. But there’s never much data behind it.

In reality, very few active managers have outperformed during market stress. Not during the tech wreck, the GFC, the COVID crash, or in the recent rate-hiking cycle. Jason Zweig summed it up well back in 2017:
https://jasonzweig.com/sorry-stock-pickers-history-shows-you-underperform-in-bad-markets-too/

In Australia, it’s the same story. Last year I looked at 349 of the largest active funds and found just 9.5% outperformed their benchmark over five years after fees. That includes the COVID period.
https://blog.stockspot.com.au/best-managed-funds/

S&P’s SPIVA data shows it gets even worse over longer periods. In early 2020, when markets dropped over 30%, most active funds had bigger drawdowns than their benchmarks.

This happens because active managers give up diversification in the hope of higher returns. That added concentration leads to greater risk. S&P calls this the “active manager’s conundrum”. The conditions active managers want — low volatility, high dispersion, and high correlations — only occur together about 2% of the time.
https://www.spglobal.com/spdji/en/documents/research/research-the-active-managers-conundrum.pdf

This is why I believe the long-term shift towards indexing will continue for decades. It’s hard to see active funds turning the tide while fees stay high and the data keeps showing consistent underperformance. Maybe once passive reaches 80% of total assets, the structure of the market will shift enough to give active a better shot. But we’re not there yet. Not even close.

2. There are still a lot of good fund managers

It’s true that there are some very talented people in active funds. But performance data shows that even the best ones rarely stay on top.

The SPIVA persistence report makes that clear. Out of 329 Australian Equity General funds, 96 beat the index in 2021. Only 4 of those continued to outperform every year through to the end of 2023. That’s about 2%. The numbers are only slightly better in the mid and small cap space.
https://www.spglobal.com/spdji/en/documents/spiva/persistence-scorecard-australia-year-end-2023.pdf

3. Finding a good manager can make a big difference

In theory, yes. But in practice, identifying that manager before they outperform is close to impossible. And even if you do, they often don't keep it up. Active managers are much more likely to underperform by around 3% each year after costs, fees, taxes and franking leakage.

A lot of big-name fund managers in Australia built reputations on a few good years, then struggled to sustain it. Platinum, Magellan, Perpetual — all strong performers at different points. But asset gathering success often becomes a burden. Once a manager has billions under management, incentives change. Motivation shifts. Performance drops.

At the end of the day, it’s not just about finding a great manager. It’s about being able to stick with them before they’re proven, and long after the headlines fade.

Hi Chris,

Thanks for the feedback. I am a fan of passive investing, though also see a spot for active funds in portfolios too.

Regarding your specific points:

1. Today is different from past history and we'll see what happens. It's nothing like the GFC or Covid. I think using history as prologue is dangerous. However, the setup to me looks a little like 2000, and then, there were many value fund managers who significantly outperformed indices. Many of the growth mold got creamed, but others did remarkably well ourt of the wreckage.

Assuming passive funds will float through future market disturbances seems a little presumptuous too. The passive model will be stress tested at some point too.

2. That's a short time frame and I personally know a lot more than 4 Aussie fund managers that have consistently beaten the ASX over the long term.

3. As I said, size is the enemy of performance. Look at the great Berkshire Hathaway for evidence of that.

James

As a BRK shareholder, I had a Quick Look and see that BRK has outperformed SPY over 1, 3, 5, 10 years. Am I missing something?

Ronald,

Yes, Buffett has performed well, though he performed a lot better early in his career, in the 60s, when he managed less money. His hedge fund outperformed the Dow by 23% per annum over the 11 years it ran!

As James has mentioned, SIZE is the major factor in outperformance. Size of the FUM impacts performance.

Fund managers at large funds are index huggers - they don't want to rock the boat too much so they can get another job with another company. The high achievers in such funds would leave these large equity funds to start their own boutique funds. Hence, what you have left in the large funds community are average managers in rotating chairs, and that is also why small and mid cap funds is where one can find outperformance.

Therefore, one can quote SP Global reports about 98% of large equity funds do not beat the index over longer term, but understanding the industry and how it operates would be better than just looking at "data".

James, your comments about the tide may be turning aren't just suppositions. Even Vanguard just wrote a piece for advisors saying that by not owning the top 10 stocks in the US last year, it was the biggest drag on US active fund performance since records began in 1991. And the past decade has seen continued substantial drag on active fund performance from increasing concentration of US indices.

Even Vanguard, the pioneer in index investing, expects active funds to start performing better vs indices!

Thanks James, biggest point is - if you think you have the skill to identify a good active manager that will outperform AFTER you invest then do it - it can make a very big difference. AND be willing to understand that skill only reliably overcomes luck over a long period (so don’t expect outperformance every year). But if you don’t have that skill - don’t, go and buy cheap index funds.