Don’t buy funds, buy fund houses
Asset manager shares outperformed the MSCI in 20 of the 24 calendar years between 1990 and 2013
Canny investors have long wondered whether they should consign the fund industry’s ever-multiplying mounds of glossy marketing material to the bin, and simply invest in the shares of asset managers instead.
Research by a small UK-based fund house may have gone some way to answering this question for good.
Figures collated by Guinness Asset Management show that, since 1990, an equally weighted portfolio of global asset management stocks has returned 17.9 per cent a year, amounting to a healthy 5,053 per cent in aggregate. This comfortably beats the 6.5 per cent (356 per cent in total) mustered by the MSCI World index, which in turn will have outperformed virtually every equity fund.
Cynics will rightly point out that the 1990s was a decade of extraordinarily strong market returns; asset managers, as geared plays on the market, could hardly go wrong.
But even in the period since 2000, an era pockmarked by two nasty stock market crashes, asset managers have soared above the fray, returning 9.1 per cent a year, compared with the 5 per cent of the MSCI World index.
Asset managers outperformed the MSCI in 20 of the 24 calendar years between 1990 and 2013, as well as trumping the MSCI World Financials index in 16 of the 18 years since the latter’s creation in 1996.
But the asset management sector has proved more volatile than the wider market, with quarterly volatility of 13.2 per cent since 1990, against 8.6 per cent for equities at large. Moreover the sector’s beta has averaged out at 1.35, meaning it typically rises (or falls) 35 per cent more than the underlying market.
However, using perhaps more meaningful measures of risk, investors may not have had to take a particularly large gamble at all in order to achieve these outsize returns.
Following the 2000 stock market crash, the asset management sector suffered a maximum drawdown (peak to trough fall) of 42.9 per cent, compared with the 46.2 per cent of the MSCI World. It returned to its previous peak within 12 quarters, half the time it took the wider market to recover.
The maximum drawdown was admittedly a little higher after the 2007 market crash (55.8 per cent versus 48.4 per cent for the wider market), but asset managers still returned to their previous peak a fraction faster.
“On a rolling three-year period, we cannot find a period where the asset management sector underperformed equities,” says Will Riley, co-manager of the Guinness Global Money Managers fund, set up to exploit this apparent anomaly.
“That is something that quite surprises people. I think people have this idea in their mind that it is a fair-weather sector.”
And while it is early days, the concept of investing in the industry’s shares also appears to work in practice.
The Global Money Managers fund – believed to be the only vehicle of its kind worldwide, although there are a number of broader “financials” funds – endured a poor launch year in 2011, losing 18.7 per cent.
But in 2012 it came first out of 234 funds in the IMA Global fund sector, and in 2013 it was third out of 245. Despite its difficult first year, it is third out of 215 funds in the sector during the first three years of its life, returning 64.7 per cent, compared with the 41 per cent of the MSCI World.
The fund has proved a little more volatile than the market at large, but its Sharpe ratio, a measure of risk-adjusted returns, is 0.55, compared with 0.31 for the MSCI World.
Star performers have included Polar Capital, which delivered a total return of 313 per cent during 2011-13, Azimut (238 per cent), Liontrust (217 per cent), Affiliated Managers Group (119 per cent) and Waddell & Reed (106 per cent), although Artio Global Investors did its best to upset the apple cart, slumping 80 per cent before being rescued by Aberdeen Asset Management in May 2013.
But is there a logical reason to believe any sector can consistently outperform the wider market? In the case of asset managers, Mr Riley and Tim Guinness, founder and chief investment officer of Guinness AM and co-manager of the fund, believe so.
First, they point to the industry’s unusually high returns on capital, partly a reflection of its ability to scale up with relatively little additional investment. According to Guinness, asset managers with a market capitalisation above $500m enjoyed a median cash flow return on investment of 16.7 per cent a year between 1991 and 2013, compared with 7.6 per cent for the market as a whole.
The duo also argue that asset management, like the luxury goods sector, is a “special” industry that can grow at a higher rate than the global economy for multiple decades.
Since 1990, rising household wealth has seen the industry’s assets under management rise by 700 per cent, dwarfing the 150 per cent return on global equities.
“The amount of private wealth is going from one times gross domestic product to four or five times over a 70 to 80-year period,” says Mr Guinness, who argues such an asset pile is needed to fund retirements.
“Absent a war or two, it will carry on growing. [Investing in the asset management industry] is like putting your canoe in the fastest-moving part of the stream,” adds Mr Guinness, who previously built the £13bn AUM Guinness Flight Hambro business, bought by Investec in 1998.
The managers also point to the asset management industry’s ability to raise revenues without adding new customers when equity markets rise (although this is a negative when markets fall).
And despite its strong run, the sector does not appear to be unduly expensive, trading on 14.2 times consensus 2014 earnings forecasts, a fraction below the 14.6 times of the S&P 500 index.
Tom Brown, global head of investment management at KPMG, the professional services firm, is unsurprised by the findings. He says “the profitability and share prices of fund managers will outperform the funds themselves in a rising market”, as asset-based revenues increase faster than the relatively fixed cost base of a business.
Rob Mellor, asset management partner at PwC, the consultancy, says some people did invest in asset managers as a proxy for their funds, particularly where funds may be closed to new investors.
But he cautions that the industry faced a “battle” to maintain its current level of profitability, given the incursions by low-cost passive funds. Despite this, he believes asset managers should be able to increase their market share at the expense of competitors such as insurance companies.
The Guinness fund remains small, but with a three-year record under their belts, the managers are keen to begin marketing it in earnest. However, one obvious downside remains.
Given the equal-weighted nature of the fund, and its specialist remit, Mr Riley and Mr Guinness believe they can only run a maximum of $250m in the strategy, a tiny fraction of the sum invested in funds worldwide.
Moreover, investors cannot sidestep this limit by investing in Guinness itself, as it remains owned by Mr Guinness and his staff.