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Lessons when a fund manager of the year is down 25%

“I used to rule the world
Seas would rise when I gave the word
Now in the morning I sleep alone
Sweep the streets I used to own

I used to roll the dice
Feel the fear in my enemy's eyes
Listen as the crowd would sing
"Now the old king is dead! Long live the king!"

One minute I held the key
Next the walls were closed on me
And I discovered that my castles stand
Upon pillars of salt and pillars of sand …”

Extract from Viva la Vida by Coldplay

 

Selecting an active fund manager who can outperform the market over time is even more difficult than picking stocks. A talented and skilful team may utilise a style which goes out of favour for many years, making the fund managers look below average. Investors may become frustrated with the poor performance and leave at the worst time, attracted to last year's successes.

Similarly, previous winners can go through rough patches. Many of Australia’s best-known fund managers, such as Hamish Douglass at Magellan, Andrew Clifford at Platinum, Roger Montgomery at Montgomery and Anton Tagliaferro at Investors Mutual, have struggled to match their benchmarks after fees in recent years.

Zero to hero

Consider the performance of the Lazard Select Australian Equity Fund since 2019, shown below. Its highly-regarded and experienced investment team carries a strong Silver rating from Morningstar, yet in both 2019 and 2020, it was in the bottom percentile of its category of Australian Equity Large Value (and Value also underperformed Growth). Almost last among over 100 managers surely tested the resolve of investors and analysts alike. It recovered somewhat over 2021, and in 2022 YTD, the fund is in first place, as well as in the top few over 12 months. Going from last to first in a year or two says a lot about the fortunes of fund managers.

Source: Morningstar Direct

A study of the 2021 Fund Manager of the Year

It works both ways.

In February 2021, Morningstar announced its 2021 Fund Manager of the Year awards, and Hyperion Asset Management was not only selected as the Overall winner, but also topped the separate categories of Domestic Equities – Large Cap and Domestic Equities – Small Cap. Morningstar said:

“Our 2021 winners have proven themselves to be excellent stewards of fund shareholders’ capital. Australian investors are well served by a solid lineup of quality managers, but Hyperion Asset Management wins our Overall Fund Manager of the Year award for a strong performance across all their stable of funds.”

A check on the long-term performance of the Hyperion Small Growth Companies, which scores a rare Gold fund rating from Morningstar, shows why the investment team is held in high regard. Over the 10 years to 31 March 2022, the fund returned 14.6% per annum against its index (Morningstar Australia TME GR AUD) of 10.5%. Over five years, the comparison is 13.1% versus 9.6%. In the chart below, the blue line shows the Hyperion fund versus the red line of the index.

However, in the first quarter of 2022, the fund was down 20% versus the index up 4.2%. Investors have given back a quarter of their capital relative to the index in only three months.

What lessons do the recent results versus its history give investors about selecting active managers?

Warnings in the Morningstar analysis

Writing in September 2021, Michael Malseed, Associate Director at Morningstar explained the Gold rating:

“Hyperion Small Growth Companies continues to earn our highest conviction among growth-focused small-cap managers given its deep and differentiated research, genuine long-term time horizon, and highly experienced portfolio managers.”

Then in explaining the investment process, the reasons for recent underperformance appear:

“Hyperion pays little heed to benchmark weights when constructing a concentrated portfolio of high-growth small-cap stocks. Importantly, portfolio outcomes are a function of bottom-up research and forecast long-term internal rates of return, rather than any top-down or macro thematic. Nevertheless, this approach leads to large sector skews relative to the index and peers. Technology names have traditionally dominated, accounting for more than 34% of the portfolio as of 31 July 2021 compared with the benchmark's 8% and category average of 13%. Top holdings as at that date included software-as-a-service providers Xero and Wisetech Global. Consumer cyclical is the second-largest sector exposure at just over 30%, comprising names such as Dominos Pizza, Temple & Webster, and Kogan. Healthcare stocks also prominent through exposures such as Fisher & Paykel Healthcare, Nanosonics, and Pro-Medicus. Hyperion typically holds no allocation to materials and energy stocks, reflecting its lack of confidence in the sectors’ earnings predictability and pricing power.” (my bolding).

The technology and growth stock exposure which served Hyperion well in 2020 and the first half of 2021 reversed as the market became increasingly focussed on rising interest rates. Investors turned more towards resources and energy stocks, supercharged by the Ukraine war and a shortage of commodities.

The table below of sector returns in the MSCI All Country World Index for the first quarter of 2022 shows it was almost impossible for a fund without exposure to energy and materials (resources) to match its index.

Any fund manager measured against an index with significantly different stock weightings will produce outsized volatility when the market changes.

Therein lies the challenge for investors. Morningstar considers the Hyperion team one of the best but a first-time investor on 1 January 2022 has seen a 25% underperformance. The results from selecting an active fund manager often require patience. In some cases, managers can spend years underperforming with no change in their process or the people making the decisions that once placed them top of the league tables.

Hyperion’s global fund in the listed market

For investors who prefer to invest via the listed markets, Hyperion’s Global Growth Companies ETF (ASX:HYGG) has been on the ASX since 22 March 2021. Its March 2022 fund update shows unfortunate timing, delivering a nil return versus the benchmark of up 12.2% over 12 months. The same portfolio in managed fund form has an inception date of 1 June 2014 and has returned 19.4% per annum versus the benchmark of 13.2%.

The major winners and losers over the 12 months are shown below. Some initial COVID beneficiaries such as PayPal, Spotify and Facebook (Meta Platforms) have given back much of the prior gains.

In an updated review of this fund written on 22 April 2022, Morningstar's Malseed reported under the heading ‘Backing long-term winners but patience is required’: 

“... a strong growth-style bias will likely see short-term bouts of underperformance during cyclical or value-led rotations. Investors should be prepared for higher-than-average volatility.”

Here is the price performance of HYGG since listing, and with a 12-month price range of $3.32 to $4.98, the investor experience depends on the entry point. Over April 2022, the price has fallen from $3.92 to $3.38 at the time of writing (27 April).

What do Lazard and Hyperion tell us about active managers?

Hyperion’s first Australian equity funds were launched in 2002, giving it a 20-year track record. An investment of $100,000 in its Australian Growth Companies Fund in September 2002 would have increased to $918,547 by 31 March 2022 (net of fees with distributions reinvested) versus the S&P/ASX300 at $577,076. 

It’s well established that most active fund managers do not beat their benchmarks after fees over time. It is common to see strong periods of outperformance when a style works well, but markets rarely reward a particular style forever. The 20 years is an impressive test period which shows evidence of skill rather than luck.

I am not a fund or stock analyst, and I have no intention of second-guessing my colleagues at Morningstar who spend their careers judging manager performance, but here are my takeaways:

1. Allocating to an active fund manager is a long-term decision

As Warren Buffett said, “The stock market is a device for transferring money from the impatient to the patient.” 

There is no point paying active fees for a fund manager who hugs the index, and so investors should pay for skilled managers who back their views and run large tracking errors. These stock views may take years to pay off. Investors who jump out after a bad few years are likely to be leaving at the wrong time. A decision to place confidence in an active manager should come with at least a five-year horizon, and better, eight to 10 years.

2. Investors must have realistic expectations

Consistent outperformance will not occur over all time periods. Markets always face surprises and geopolitical events are difficult to forecast. Few people expected Russia to invade Ukraine and send commodity prices surging. A fund manager such as Hyperion who is unimpressed by the lack of certainty of earnings in the resources sector will suffer in current markets, at least over the short term. Lazard's traditional value approach struggled for years. Investing can face a long disappointment before a thesis pays off.

3. Funds may be vulnerable after a hot streak

A manager that has done well for many years and continues to hold the same stocks probably manages a portfolio that has become more expensive over time, absent evidence its companies are increasing earnings. This so-called ‘Price/Earnings expansion’ occurs when investors become more confident about long-term prospects and are willing to pay more for each dollar of earnings. Prior to the current monetary tightening phase, the fall in interest rates also encouraged this expansion. But markets change, rates are rising, and there is likely to be some reversion to the mean after a hot streak. 

4. Watch for style changes

Fund managers who experience a period of underperformance may feel pressure to change their stock selection process. Many a value manager who suffered through a decade of growth stocks winning and a move to tech felt the challenge and criticism of sticking to traditional, boring industrial companies.

It’s an obvious reaction to judge the quality of an investment by its success, or what is known as ‘outcome bias’. A good outcome always looks like a good investment, but an unfavourable outcome may be due to bad luck in a rapidly-changing world, rather than a fund manager’s investment process being fundamentally weak.

5. There should be a uniform and consistent message

Hyperion advises on its website:

"Our funds are designed for investors with a long-term investment outlook, so we recommend looking at 10-year performance where available to appropriately assess growth prospects.

Convention has Hyperion’s portfolios benchmarked against the relevant equities indices. This is something we acknowledge for the sake of reporting but studiously ignore when it comes to making investment decisions."

Exactly right. It was a lapse to highlight the short term when on 29 July 2020, Hyperion issued a media release headed “Hyperion Asset Management top performer over two decades”. Fair enough. Every fund manager on earth would be proud of this achievement and use it to promote their funds.

But then Managing Director and Chief Investment Officer, Mark Arnold said,

“Our performance demonstrates that it is possible to take a long-term view and deliver short-term results with the same fund, growing our investors’ money through lean times and bountiful. We design our portfolios in a way that allows us to consistently profit from market highs as well as to protect capital during periods of market volatility. Our results prove that you do not need to use complex hedging strategies and derivative products to protect your capital during downside movements.” (my bolding)

While the time frames assumed in this comment are relevant, losing 20% to 25% in a quarter does not meet the test of 'protecting capital'. Hyperion went on to quote data compiled by S&P in its SPIVA report on Australia that:

“ ... over the 10- and 15-year periods, 83.9% and 85.30% of Australian equity general funds underperformed the S&P/ASX 200 on an absolute basis respectively. The findings demonstrate that Hyperion is one of a very small group of managers able to consistently outperform over the short and long term.”

Perhaps Hyperion does not consider one year to be short term, but many investors would. Here are the one-year and three-year results sourced from their website as at 31 March 2022.

Hyperion funds net performance versus index

Fund

1 year

3 years

Global Growth Companies Fund

-12.2%

+4.8%

Australian Growth Companies Fund

-10.9%

+5.9%

Small Growth Companies Fund

-11.9%

+2.5%

Mark Arnold went further, describing a “strict proprietary investment process which allows the team to separate the winners from the losers.”

Does 'separated' mean the losers are avoided? Roku (down 61%) or PayPal (down 52%) suggest otherwise, and a stock that falls 50% needs to rise 100% to recover the loss.

Hyperion should be well satisfied with the results delivered over two decades but they should temper their claims to reflect a style which will inevitably deliver periods of underperformance that may last at least a year, and probably longer.

Take it away, Coldplay

The final verse of Viva la Vida is a warning that the market can bring every investor down to earth. Even when the investment process is not built "upon pillars of salt and pillars of sand", those who want to be king need to prepare for a period when the monarchy is unfashionable.

"Revolutionaries wait
For my head on a silver plate
Just a puppet on a lonely string
Oh who would ever want to be king?”

 

Graham Hand is Editor-at-Large for Firstlinks. This article is general information and does not consider the circumstances of any investor. Disclosure: Graham owns a small investment in the listed HYGG.

Extracts from Viva la Vida by Coldplay. Copyright, Universal Music. The concert recorded live in Sao Paulo, Brazil, is extraordinary. The song reached Number One on the Billboard 100 and UK Singles Chart and won Song of the Year at the Grammy Awards in 2009.

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25 Comments
James
May 07, 2022

Very interesting article. I had been searching for articles on Hyperion since the tech/growth rout started, as I knew they would be hardest hit. Claims of capital protection were always questionable and still are. You only have to look at the global fund and see that their bet on Tesla alone is in excess of 10% of the fund. That is super aggressive.

The reality is they are vulnerable to considerable downside risk - full stop. I think it is unfair to ignore their long term performance, as it has been stellar. However, it is important to consider the backdrop of when this outperformance occurred. That very backdrop looks very different now and more importantly, looks to be very different for the next decade.

In summary, I think it is fair to be annoyed at the claims of capital protection. Any person, trained or untrained, could look at their stock selection and realise it’s not only growth oriented - but highly susceptible to downside risk. It’s a classic case of risk/reward. Up until a couple of months ago, the rewards were amazing.

I also remember reading and watching a video of Mark outlining the supposed death of value style investing - which is nonsensical. Fundamentals are exactly that and always play a part.

I am very interested to know how this plays out and whether the ultra growth style of Hyperion continues in the face of growing distaste of ultra expensive tech/growth stocks.

All things considered, growth style investing had an amazing run. Over a decade of dominance, which some, including Hyperion predicted would never end.

Only problem. It has.

Alan B
May 01, 2022

Comparing the recent prices of various bond type ETFs, I notice they are all down too from their peak prices. Approx percentages they have fallen: BOND -15%, CRED -20%, EBND -18%, IHCB -15%, IHEB -25%, IHHY -14%, PLUS -13%, VGB -14%, VBND -20%. NDQ which tracks the NASDAQ is down 18% from Nov 2021.
If one LIC or ETF has fallen it doesn't really bother me if all other funds and ETFs have gone down too. I worry if my fund or ETF has fallen when all others have risen. Fund manager perforance is mostly just luck (ascribed to skill if good performance or deteriorating market conditions if bad performance) and all fund manager/ETF results basically just follow the market (ok Buffett excluded). A rising tide floats all boats. And vice versa.
Perhaps Cold Play was singing about fund managers:
"For some reason I can't explain
Once you go there was never
Never an honest word"

Pete L
May 01, 2022

CC, In support of Barry, all funds “fluctuate”; it’s the only thing they are guaranteed to do !
BUT I would suggest a 25% loss over that time in a “managed” fund, suggests that capital protection runs secondary to a “hold and hope” investment strategy. Barry is correct in the sense that there appears to be VERY little capital protection involved and that shareholders (or fund holders) appear to be “locked in” to the fund in the hope of at least recovering their capital, let alone making a gain. It’s great to be able to recommend that shareholders take a long term approach when their fund is rising, it’s fairly hollow advice when that shareholders has lost a quarter of his investment in a comparatively short time. So, are you implying to Barry, that all he has to do is to wait another 8 years to find out if he is going to get a reasonable return ? Either that or take a 25% loss !

CC
May 01, 2022

Unless you buy a long short or market neutral fund, there is no such thing as capital protection in an equity fund therefore long term approach is needed. Buffett once said that if you can't stomach your equities falling by 50%, you should stay out of the stockmarket.

Active or Passive what is long term.
May 01, 2022

Having watched fund managers for 30 Years plus, a strategy is whoever is awarded Fund MAnager of the year, sell, as often they fall for a year or two. Morningstar rates active management so justifying them makes sense. I agree Hyperion has been exceptional over the 10 year plus time frame. Got caught in the end of Covid shifts. I am still wondering how to make my investing interesting if in passive style options for investment.

Steve
April 29, 2022

A problem with a 20 year track record is you are comparing results from decisions made up to 20 years ago. Are the people responsible for this the same people today? And concentration in the right sector (tech) obviously helps, but falling 25% suggests an inability to lock in profits and move to other investment options? I mean no-one was saying you should put some cash aside in the last 12 months were they........

steve mccarthy
April 30, 2022

For an assistance with your question you only have to look at PTM, hero to zero. Both owners have taken their $billions and fled, leaving investors very much the poorer! The interesting thing about managing OPM is this, if you do your own research, remove emotion, be dedicated, read and research sectors of interest. Then create a fake portfolio, then buy and trade for a year and component your wins and losses. On average you will outperform some, underperform some, and equal most! Only difference will be you are not taking home on average $350k plus a bonus salary in a good year.
Funds management is a fake industry that charges plenty, delivers little, but holds itself out to be in the genius category in good times!

Mark
April 28, 2022

I have held HYGG for a couple of years and my take from reading the above advertorial is that they've simply adopted a "set and forget" strategy dressed up as "Active" management. This supposed "active" strategy ignores the gyrations of the market and any particular sector i.e. energy and materials. Hyperion will be actively following the Tech sector all the way to the bottom I suspect. Also, I would be interested to know if the majority of the investors (presumably retired) in HYGG can afford to wait for the Active managers to be "vindicated" when the market moves back in their favour... in 2, 4, 6 years time... who knows. I want YOY returns - I understand it could be a few % some years, or double digits in other years and if this means being "active" well, isn't that why you "get paid the big bucks"?

Graham Hand
April 29, 2022

Hi Mark, putting aside the fact that you could not have held HYGG for 'a couple of years' (it launched on 22 March 2021), if you consider it an 'advertorial' when I highlight that a fund has underperformed by 25% and it should deliver more consistent messages, then it shows we can't please all the people all the time.

Mark
May 01, 2022

Thanks at least for replying Graham.
I acknowledge my error... yes, I have held HYGG for under 2 yrs. Maybe it just seems longer !
OK... they've dropped 25% in LESS than 2 yrs !

The point is, that it's reasonable to expect active managers to be active, don't you?
I want them to respond to the market as it changes, not make a virtue out of sticking with a failed strategy.
I don't know what the journalistic term is but I think you've written an "excuse piece".
In effect - "hey, they might be down 25% but here are some good reasons why."
Finally... your "can't please all the people" comment is a bit churlish. I'd like to hear from ANY of your readers if they are happy with a 25% drop in less than 2 yrs (when it could POSSIBLY have been avoided).

Steve Dodds
May 16, 2022

I've held HYGG via the previous managed fund for over two years.

As such, despite the recent falls, I am still in the black.

Or at least I was when I cashed out of it (and the Australian Growth Fund) a couple of weeks back.

Those funds are now in a boring value-inclined passive fund (VHY).

Peter Scott
April 28, 2022

My investment in Platinum Asset Mngt; has halved since buying some 12 years ago.
I still believe they will come good long term; hope my optimism is not misplaced.
As Buffet says; the market is a device for transferring money from the impatient to the patient.

Here's hoping!

Scott
April 28, 2022

Peter, buying the ASX listed stock Platinum (PTM) and investing in a Platinum fund are completely different things. While PTM may have halved over the decade, investing in the Platinum International Fund returned 10% per annum over that period according to their website. Don't confuse investing in the common equity of a company with investing in a portfolio of listed securities. Your optimism assumes that the market valuation of the company's future revenues will grow.

Bruno
April 28, 2022

Just because shares once traded at a price doesn't mean they're actually worth that much, or will get there again. You have to look at the operating trends/earnings trajectory of the company. Is Platinum prospering? If so maybe they will come good. If they're experiencing large and ongoing outflows then maybe not.

Will AMP shares get back to the $20+ they were at IPO?

Hope is not a strategy

BeenThereB4
April 28, 2022

Hearts and Minds (HM1) doesn't look too flash.

Present price is about 50% of high in early March

Would you catch this falling knife ???

John
April 28, 2022

In about 1999, I saw a presentation looking at the rankings of each of the Australian Fund managers. It ranked them from 1 to 50 (or whatever it was) - from best to worst, for the year ending 1997 and then ranked them (again from 1 to 50) for the year ending 1998. Then it graphed the change in ranking.
From memory, there didn't seem to be any correlation between their rank in 1997 to that in 1998.
Perhaps morningstar could do a similar exercise for the calendar years ending 31 Dec 2020 and 31 Dec 2021 - by all means leave off the names of the fund managers - we are not looking for the "best performing" manager, just looking to see if how much change there is in ranking from one year to another

AI
April 28, 2022

FMotY is often the kiss of performance death - approach with caution. This applies to any high flier really, it is much better to have a consistent Q2 performing fund over time than chasing whichever of the constantly changing set of Q1s - a consistent Q2 will be Q1 over the long term

Alex
April 28, 2022

The more salient point is not whether a fund manager's style goes out of favour, implying the market is wrong and they are right. It is whether the fund manager hit on a single winning idea for a while (tech to the moon?) rather than doing the hard work on fundamentals.

Joey
April 28, 2022

The "pillars of salt and pillars of sand" are the startup tech and retail companies who spend $150 in marketing and advertising to acquire each customer, plough through millions in capital provided by angel investors on the back of increases in customers, but its all 'profitless prosperity'. Once the advertising is switched off, the eyeballs go to the next sucker and the investors realise it was a mirage. And some stocks have fallen 80% from the mania of 2021.

Mart
April 28, 2022

So .... thoughts on active managers versus a LIC or ETF (buy, hold, reinvest dividends) approach ? Mix of both ?

Chas
April 28, 2022

I tend to disagree with the sentiment of the article. Fund managers also change over time and some make terrible decisions . I would no longer trust a fund manager who, for example decided ( before Ukraine) to go woke and get out of oil and gas, when clearly there was going to be growing demand due to the majors reducing exploration , no major oil and gas projects in the pipeline , and renewables simply unable to fill the void. There have been numerous other investments that were simply never going to work like Afterpay. For these reasons I manage my own SMSF and have done exceedingly better than nearly all fund managers .

Barry
April 27, 2022

Reminds me of the Buffett quote: “Only when the tide goes out do you discover who's been swimming naked.”

CC
April 28, 2022

Barry, that's an unfair criticism of Hyperion. They have a very longstanding well processed growth style that cannot be called "swimming naked "
Whilst they have underperformed in the past year they are still well ahead on 10 and 15 year performance figures.
Despite the past year's losses, their Aussie large cap & small cap funds have 10 year nett per annum returns of 13.9% and 14.2% , and since inception in 2002 ( note this includes the GFC years !! ) nett 12% and 14% p.a. respectively. Those are astoundingly good 20 year performance figures which included the GFC.
Their younger global fund has returned 18% p.a nett over 7yrs.
Whereas Value style managers have outperformed over the past year but have underperformed on 10 year figures, some of them quite shockingly.

Barry
April 30, 2022

I don't care what the past performance is. You can't buy food with past performance. You can't go to the bank and borrow against past performance. What really matters is what the investment will produce in the future after you invest. Bernie Madoff had an excellent past performance too "until the tide went out" as Buffett calls it.

This article is talking about how Hyperion were pumping their chest saying that they will protect your capital from the downside, but then when the time came, that was revealed to be just another empty promise as they did nothing to protect from the downside and they lost 25% of their customer's money when the tide went out.

CC
May 01, 2022

but Barry show me an equities managed fund, LIC or ETF ( active or passive ) that only goes up in a straight line and never has down periods ! that's the nature of the beast in equities and why long term investing is more reliable.

 

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