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Are star fund managers a blessing or a curse?

Lewis Jackson  |  22 Dec 2021Text size  Decrease  Increase  |  
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A string of bad news has sent Magellan careening. Months of underperformance in its flagship Global fund were capped in quick succession by the surprise resignation of chief executive Dr Brett Cairns, news co-founder Hamish Douglass is separating from his wife, and the loss of the fund’s biggest institutional client.

All eyes are now on whether Douglass can rediscover his 'magic touch' and begin to reverse Magellan Financial Group's (ASX: MFG) 62% share price rout and billions in outflows.

But the spotlight on Douglass raises a broader issue for all fund investors: key person risk. Beneath every star manager with a flair for stock picking lurks the danger of underperformance if they leave, fall sick or are deserted by lady luck.

Should investors be concerned about key person risk? Do marital woes spell trouble for investors? And what are the signs to look out for? We spoke with Ross Macmillan, a senior analyst in Morningstar's manager research team about how he approaches the issue when assessing funds.

What is key person risk and how can it play out?

Key-person risk arises when a fund relies heavily on a person(s) for decision making and investing. They can become so important to the fund’s stock-picking and brand that their exit or distraction poses a risk to performance and fund flows.

The issue extends to famous chief executives. Imagine Tesla without Elon Musk or Berkshire Hathaway absent Buffett.

Markets are focused on marital issues in the wake of Hamish Douglass’ separation, but key person risk takes many forms, says Macmillan.

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Illness can be just as disruptive. Co-founder of Platypus Australian Equities, Donald Williams, retired for health reasons in 2016. Small boutiques especially run the risk their star performer falls ill, retires or leaves.

Then there are exits. Big funds need to avoid their star performers walking away to set up competing firms. Platinum co-chief investment officer Jacob Mitchell walked out the door in 2014 to set up rival manager Antipodes. Those that stay court danger when they become indistinguishable from the fund, consider how Cathy Wood is now synonymous with Ark Invest.

“It's an issue with every strategy,” says Macmillan.

“Whether it's what's happening with their personal lives, whether it's due to illness or just some unexpected event.”

Is your fund taking steps to address it?

With the risk present in most funds, investors should ask whether funds are taking steps to address the key person risk, says Macmillan. Even a great portfolio manager can be brought down by a weaker team or the lack of a strong succession plan.

“People say, oh, that fund has got a great portfolio manager. How come you only rate them above average and not high?”

“It's because maybe they don't have a great succession plan in place. Maybe the team behind them aren't as good. Yes, sure. You've got one great person. But you've got to look at the holistic picture of the investment team.

One way to mitigate the issue is spreading the load more widely, whether across the investment team or co-portfolio managers. Macmillan cites Elly Griffiths, founded by Ben Griffiths and Brian Ely in 2002. When Brian Ely retired in 2015, Ben Griffiths provided stability for the strategy.

Also important is the succession strategy, having someone ready and able to take over if needed. When Donald Williams at Platypus Australian Equities retired for health reasons, deputy portfolio manager Prasad Patkar was ready for the role, having already worked with Donald for many years, says Macmillan.

Magellan is an example where a large team and a long-term strategy mitigates against key person risk, says Morningstar equity analyst Shaun Ler.

Chief executive Brett Cairns oversaw new products and operations, so his exit leaves the investment team untouched, says Ler. Meanwhile, Hamish Douglass is supported by a group of 50, none of whom have left.

Then there’s the strategy. Magellan’s global strategy buys and holds stocks over the long term. That requires less day-to-day oversight compared to hedge funds trading hundreds of stocks per day. In turn, it means less pressure on the fund manager.

“We do not want to speculate around what Hamish should do with his life,” says Ler.

“But if we just take a step back and look at what is the Magellan global strategy, it is a patient buy and hold shop that has less than 20% annual turnover per year. Time does much of the work for the portfolio manager.”

Don’t lose (that much) sleep

When it happens, fading star power is serious. Morningstar will consider downgrading a fund, especially where the replacement is less experienced, says Macmillan. Investors should also recognise a fund’s investment philosophy and process can shift under new leadership. The bottom line is uncertainty.

Should investors worry? A little but not a lot, says Macmillan. The investing world is full of managers who stick around into old age, think legends Warren Buffett and Charlie Munger. Most fund managers do what they do because they love it, and that’s good news for investors.

“In most cases, a portfolio manager will stay where they are and keep working until they are 100,” he says.

“It’s a low probability but it’s something we need to think about, and we do think about it every time we do a fund review.”

is a reporter and data journalist with Morningstar. Tweet him @lewjackk or get in touch via email

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