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Don’t follow the crowd, or the fund manager, when it comes to investing

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Thursday April 25, 2013 at 9:00am
Last week saw another good example of emotion and the herd instinct at work in the investment world. Richard Buxton is one of the UK’s most popular active fund managers where he manages the UK Alpha plus fund for Schroders. He has announced that he is leaving and he is going to join Old Mutual, another fund manager. Such is his following amongst investors that Schroders have warned that almost one third of the UK Alpha plus fund is at risk of being sold as investors withdraw their money and put it into Mr Buxton’s next fund.

But very few people really know what the UK Alpha plus fund invests in and they probably don’t care, they are simply backing a manager. However the essence of good investing is to understand where the best returns are to be found, and why.

Why the academics say “Don’t follow the manager”

A great deal of research has been done on what type of companies provide the highest stock market returns. Not surprisingly the academics tell us that companies with lower stock market valuations, so called small cap shares, outperform their larger sized brethren over the long term. Likewise those companies that have a market value similar to their accounting net asset value, so called value shares also outperform the market as a whole over the longer term.

The reason for this apparent anomaly is quite straight forward; companies that are of low market capitalisation and those companies that trade at a valuation close to their book value carry more risk. Hence the investor is rewarded for taking this extra risk by receiving a higher return.

Academic research shows that it is virtually impossible to consistently outperform the market by picking shares. The stock market provides a higher return than fixed interest investments simply because the investor is being asked to take on more risk.

The key for investors is to capture this market return and not squander it on high fund charges and unknown risk that comes from not holding all of the market.

What does the UK Alpha Plus Fund invest in?

The Morningstar billing is that the fund buys large companies with no particular bias towards value or growth shares. However, in reality the fund has a bias towards smaller companies when compared to the market average against which it is measured. Hence, as the fund actually invests in smaller companies, which are known to outperform the overall market over time, this would account for its outperformance against its benchmark. Given the fund’s claim to invest in larger companies this means some investors are taking more risk than they think.

Compared to other Small Cap funds the UK Alpha Plus fund is simply ‘ok’. For example, over the past 10 years the Dimensional UK Small Cap Index, the fund we use in most of our client portfolios, has an annualised return of 11.5%. This compares to 11.2% from the Schroder UK Alpha Plus and 7.71% for the FTSE All Share Index.

An investment lesson learned

Yet again the academics are right, successful investing is more about understanding where the market return comes from (investing in smaller capitalised shares in the above example) than about following the crowd and fund managers.

If you would like to understand more about our investment philosophy at Parker drop me a line.

Andy Parker
Chartered Financial Planner

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Parker Chartered Accountants and Financial Advisors is the trading name for PLW Advisors Ltd (Registered No. 10396831), and Parker Financial Planning LLP (Registered No. OC347027). Parker Financial Planning LLP is authorised and regulated by the Financial Conduct Authority. All companies are registered in England and Wales – registered office contact details here