Will Magellan Global fund's underperformance persist?

Investors are told to think-long term. If you're focused on tomorrow, next week, next month, you're trading, not investing. But when a fund like Magellan Global falls from grace, even momentarily, people take notice.

The gold-rated Magellan Global Open Class fund had its worst year in a decade in 2020, delivering investors a negative return (-0.2 per cent) and underperforming both the Morningstar World Large Blend category (5.69 per cent) and the MSCI World Ex Australia NR AUD index (5.73 per cent). While performance held-up against the index for most of the year, providing superior downside protection in the Feb/March covid-downturn, the fund came unstuck in the last two months, giving back all its outperformance.

Magellan Global monthly return (%), 2020

The fund was down -8.69 per cent against the index in November.

Source: Morningstar Direct

Morningstar fund analyst Chris Tate says Magellan's returns were hampered by three key decisions lead portfolio manager and Warren Buffett-disciple Hamish Douglass took during the year: a big bet on Chinese e-commerce giant's Alibaba; energy sector exposure; and a dash for cash in the March-downturn.

"Magellan had a couple of stock specific issues,” Tate says. “Alibaba, which they held an 8 per cent position in September, fell over 20 per cent in November and December after the Ant IPO was abruptly pulled. Tencent similarly fell amid regulatory concerns.

"On sector exposure, there was big rotation late in the year to cyclical stocks as investors sought to take on more risk on the back of positive vaccine news. Magellan owned three defensive energy companies, the biggest of which was Xcel Energy Inc, which sold off savagely as a result.

"Lastly, a sizeable cash holding in April and May also held the fund back in the strong market rebound."

Magellan Global Portfolio Holdings at September 2020 (Top 10)

Source: Morningstar Direct

At the end of 2019 Magellan was sitting on just 6 per cent in cash. Fast forward to a 2020 wracked by coronavirus, and its cash holding swelled to 16 per cent. Meanwhile, global equity markets rebounded strongly from March-lows, led by US mega-firms like Nvidia,  Amazon and Tesla. By June, the S&P 500 was back to its December 2019 and the NASDAQ soared to new heights.

Not out of the woods yet

Tate attributes Douglass' cautious posture to scepticism about the effectiveness of the global vaccine rollout and concerns of mutation risk in light of the more transmissible South African strain. Douglass told investors in January the biggest risk the world faced was "that the virus might mutate in a way that reduces the effectiveness of the vaccines developed so far".

"No one can accurately gauge the probability of whether or not the current mutations or an escape mutation might make the vaccines we have ineffective," he said.

"Now is not the time to be oblivious to the pandemic risk, especially given infections we are seeing in Latin America, the UK and the US. Hold on to your chairs if investors suddenly decide that a mutant strain has rendered ineffective the vaccines that drove the November rally."

Tate says Magellan is also unapologetic about wanting to protect investors on the downside.

"Do I lose sleep over missing out on some of this short-term rally? No. Our aim is to deliver satisfactory returns while protecting people’s capital," Douglass says.

Magellan's underperformance follows an exceptional track report since inception in 2007. Magellan Global has thumped both the index and category peers, as well as delivering downside protection in 2008, 2011, and late 2018.

"The risk-management profile of the portfolio came to the fore in the last quarter of 2018 when defensive consumer franchise holdings such as Yum Brands, McDonalds, and Starbucks offset falls from Apple and Facebook," former Morningstar fund analyst Andrew Miles said. 

"For the second half of 2018 the strategy achieved a 1.6 per cent return versus the benchmark’s 4.6 per cent decline."

Its exceptional track record in not without blemishes. In 2016, Magellan Global underperformed the index by -4.21 per cent, wrong-footed by Brexit and falling bond yields in the first half, and the Trump reflation trade in the second. But that was short lived. In 2017, performance improved, and the strategy edged out the benchmark in what was a strong year for global equities. This was doubly impressive given a minimal exposure to the strongly performing emerging markets. This performance carried into 2018, buoyed by tech holdings like Apple, Facebook, and Microsoft in the first half.

Measured over all rolling three-year periods from its inception in June 2007 to 30 March 2020, the strategy has achieved peer-average beating returns 89 per cent of the time.

In Magellan we trust

Morningstar equity analyst Shaun Ler believes loyal investors will stick by Douglass, one of the canniest stockpickers the Australian market has to offer. He sees opportunities for Magellan to grow assets under management, making note of the Magellan Global fund restructure and broadening of its addressable market with a low-cost ETF. 

"Even if Magellan underperforms at times in future, we think net outflows are likely to be limited and temporary given the durability of its economic moat," Ler says. "There were only 2 months of net outflows over the course of 2016-17 following Magellan's subpar performance in 2016."

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Consistent outperformance has attracted investor dollars. Magellan manages more than $100 billion, with over $75 billion in global equity strategies, placing it within the top five largest in-house managers in Australia (TAUM).

Asked whether 2020's underperformance should be a cause for investor concern, Tate gives an emphatic "no".

"If you take out the last two months of 2020, Magellan had a good year," he says. "Really, they had one stock specific issue, and were tripped up by a pretty niche market rotation. They've clearly done a lot of research – it's not unrealistic to believe the market has got ahead of itself at the point."

Douglass has now sold down his cash position, which in January sat at around 7 per cent of the fund. Today, the portfolio has strong defensive characteristics with 50 per cent in cash and high-quality defensive equities. Douglass told investors that with markets at all-time highs there is "little margin for error." 

"We think it appropriate to focus on protecting the downside, especially given the continued scientific uncertainty with the pandemic," he says.

Tate says uncertainty remains over Magellan's short-term performance. "They'll do well if volatility returns to the market; if it keeps going up in a straight line they could lag." However, he hesitates to describe their position as bearish, pointing out that the strategy continues to hold a host of quality growth names.

"They're taking a slightly more cautious stance than the market and focusing on capital protection."