One of the bigger furphies in the funds industry is that portfolio managers must invest all their personal wealth in their own fund to 'align their interests' with their clients. It is supposed to ensure they work longer hours, turn over more stones, travel the world looking for the best companies and avoid the 'spend more time with the family' syndrome.

More accurate is that every fund manager is desperate for their fund to perform well, and putting 100% of their wealth in one strategy is poor asset allocation and likely to lead to more sleepless nights and worse personal relationships than are good for anyone's physical and mental health, and the fund's performance.

Next time this mantra is espoused by a fund manager, ask these questions:

"How is your performance improved by you holding nearly all your wealth in your fund? Will you work harder and better? Should I feel reassured when my $100,000 in your fund falls to $80,000 but your $5 million falls to $4 million? Why does it make sense for your wealth to be invested in your volatile small company fund?"

Funds management looks like (and often is) a glamorous job but every day is a competition against similarly-talented and driven people, both inside and outside their own firm. Imagine what happens when an analyst spends a month researching a company and deciding it is a strong buy, then after pitching the idea to colleagues, the proposal is rejected. It can feel like a takedown on a professional judgement. If a stock idea is rejected and then it rises strongly, everyone in the office knows and bonuses and pay increases may be hit.

For example, emotions are running high in some investment teams as Nvidia's (NVDA) price rises and falls and rises with changing market sentiment towards AI.

Despite its extraordinary rise in 2023, Nvidia is not back to the US$330 price reached in 2021. Pity the portfolio manager who bought in late 2021, giving up in October 2022 at US$112 as the stock collapsed, and it is now US$306. It's one thing to miss a trend like this. It's another to invest in it and exit just before it takes off again.

Source: Morningstar Premium

I have sat in the same office as fund managers whose arguments with colleagues are so aggressive and vitriolic that it's a wonder they can work together. I have seen stockbrokers black-banned for months by fund managers who feel an order was filled badly or a piece of information was withheld. It can be a tense environment where losing 1% in returns can mean underperforming a benchmark. For large super funds, it might mean a warning must be issued to all fund members and ultimately the threat of closure.

At the 2023 Morningstar Investor Conference yesterday, Mark Delaney, the Chief Investment Officer at AustralianSuper, made the surprising statement that only one in three active managers comes good after a period of poor performance, and he had often been too slow to terminate a mandate.

“When you look back, you should have got rid of them when you first start to worry about them.”

And yet the index performance against which the manager is measured may be driven by market activity bordering on irrational, such as the buy now, pay later (BNPL) or crypto or tech wreck frenzies.

There is a remarkable event underway in the US which is driving up indexes (such as the S&P500 and NASDAQ) and causing massive winners and losers among global equity managers. When large companies make big moves, the funds which do not hold them are destined to deliver underperformance relative to their benchmark. 

In calendar year 2023 to date, Apple (AAPL), Microsoft (MSFT), Nvidia, Alphabet (GOOG) and Meta (META) account for over 80% of the S&P500's returns. This chart from The Daily Shot shows Apple and Microsoft alone have caused nearly half the rise in the S&P500, and any managed fund that does not own these two stocks will struggle to keep up.

Source: The Daily Shot

We even see the strange position where fund reports explain performance in terms of stocks not held. Here is an example from an April report of a leading Australian global manager:

Tesla (no holding)
Tesla shares declined over 20% in April after reporting lacklustre Q1 2023 earnings. Tesla pushed through aggressive price cuts to fend off competitors which impacted margins. Despite the company’s manufacturing, brand, autonomous software, and US subsidies advantages, we believe the assumptions required to underwrite an acceptable return on Tesla shares are too high to justify holding a position in the Fund."

The fund did well in April because it did not hold Tesla. And many fund managers will soon report that they did poorly because they did not hold Nvidia and Microsoft.

Another side of the less-than-glamorous industry is when a fund simply cannot attract investors, and there are plenty that quietly shut down after starting with such optimism.

We hear more about the successes but it's a grind if it doesn't work.

For example, this week, Blue Orbit, a boutique small-cap fund manager formed in 2018 advised the market:

"After five years of hard work, real innovation, and a roller coaster ride of emotion, we are now selling/closing down Blue Orbit. The performance of our global small caps fund was very good - excellent versus most of our peers globally - but we were simply unable to raise enough funds. Both the global and Australian small caps funds are now closed."

It's tough. In the office by 7.00 each morning, read the newspapers, check every screen, meet with company management, slog through endless annual reports, debate furiously with colleagues, then do well but nobody wants you. Since inception, the fund was a decent 1.3% ahead of its index after fees when it last reported.

In funds management, it's difficult to know whether someone has a good track record because of skill, luck, membership of a talented team or because a particular style works for a while.

While the data on active manager performance versus their benchmarks is not flattering, investors should be sympathetic if they miss out for while due to ignoring a bubble. Given time, they might be right.