When a fund manager performs well, it’s not long before the money starts to pour in from investors wanting part of the action.
The fund will balloon in size – sometimes to billions of pounds – and then something strange can happen: performance turns lacklustre or even disappointing.
This may be because the fund manager struggles to adapt to the new-found pressure to keep up their reputation.
Taking off: Investors have an alternative approach to piggybacking on existing winners: backing a smaller up-and-coming fund in its early stages
Or perhaps they have to compromise their investment style now they are running a larger portfolio.
Investors have an alternative approach to piggybacking on existing winners: backing a smaller up-and-coming fund in its early stages.
This can be risky and requires a leap of faith. But it can offer investors the chance to catch the early returns, which in some cases can be stellar.
‘The key is to invest when a track record is created rather than lived off,’ says Rob Burdett, co-head of the multi-manager team at BMO Global Asset Management.
‘The star fund manager culture means that funds can grow very fast once they are in the spotlight and I think that generally brings diminishing returns.
This is why it is worth looking at smaller funds, particularly if they are starting to perform quite well.’
Of course, not all small funds perform better than large ones, but they are often worth considering.
Mick Gilligan, a partner at wealth manager Killik & Co, agrees. He says fund managers have the most to prove during the early stages because their fund will not survive if performance disappoints. ‘This adds up to a big incentive for the manager to execute well in the early days,’ he adds.
THINK SMALL… AND SOME OF THE ADVANTAGES CAN BE HUGE
Managers of small funds can generally invest in companies of any size, wherever they see the best opportunities.
They can tap into smaller companies – which tend to experience faster growth – as well as larger ones, which are more established.
But managers of larger funds can find they are restricted to investing in big companies.
After all, if you have billions of pounds to invest, it can be hard to find enough good small companies to spread them between. It may also not be appropriate to make huge investments in small companies.
If you are considering investing in a fund with less than £150million in assets, find out why it is small.
Alternative: If a fund is growing fast, investors may want to consider putting their money in a smaller alternative in order to reap better returns
It may be that the manager is new to heading their own fund. If so, research their previous experience and investment process and whether they have worked alongside any well-known names.
Sometimes experienced fund managers start new funds. In this case, find out if they are sticking with the style that served them well in the past or trying out something new.
When a fund manager changes tack, there is a risk they are no longer playing to their strengths.
Hubris can kick in after a period of strong returns, leading a fund manager to believe they can reject their tried and tested strategy to perform even better with a new one.
However, just because they are sticking with what they know doesn’t mean they will continue to be successful.
Research whether they have performed well in different market conditions as well. You can find answers in the fund’s own literature or on fund research websites, such as Trustnet.
Another reason a fund may be small is that it is shrinking. In that case, you will probably want to avoid it at all costs.
Perhaps unhappy investors are withdrawing their cash following a period of disappointing performance, or a well-known manager has departed.
To find out if either is the case, Laith Khalaf, head of investment analysis at wealth platform AJ Bell, suggests looking at the fund’s annual report. This will disclose whether the units in the fund have increased or decreased over time.
If a fund gets too small, its future is in danger. ‘Small funds must remain viable, or they risk being shut down,’ says Andrew Wilson, chief investment officer at wealth manager Lockhart Capital Management.
There are fixed costs associated with running a fund, regardless of its size. Larger funds can split these costs among more investors. But for smaller ones, the charge per investor can be higher.
However, sometimes asset managers will absorb the extra costs for a new fund so that investors are not put off. Some even offer reduced fees via an ‘early bird’ share class.
WHO ARE TOMORROW’S STAR FUND MANAGERS?
So who are the potential stars of tomorrow? Lockhart’s Wilson cites Richard Penny’s Crux UK Special Situations fund as one to watch.
Penny, who previously made a name for himself at Legal & General Investment Management, has established an enviable track record since joining Crux Asset Management in October 2018.
His UK Special Situations fund, which is £103million in size and targets undervalued British companies, has turned a £1,000 investment into £1,400 over this period.
‘Going through the £100million threshold shouldn’t slow down performance,’ Wilson says.
BMO’s Burdett highlights Jeremy Hewlett as another experienced fund manager at the helm of a smaller fund.
Mirabaud UK Equity High Alpha is £68million in size and has turned a £1,000 investment into a little under £1,350 over the past three years.
For investors looking for opportunities outside the UK, Burdett says the SVS BambuBlack Asia ex-Japan All-Cap fund is one to consider.
The £48 million portfolio invests across the Asia Pacific region (excluding Japan) and is managed by Jane Andrews, who has more than 30 years’ experience. Since August 2018, the fund has turned a £1,000 investment into £1,400.
If a sub-£150million fund feels too risky, AJ Bell’s Khalaf says Schroder Global Equity Income could be one to consider.
The £263million portfolio is managed by the experienced Nick Kirrage. Performance was lacklustre until last summer.
A £1,000 investment three years ago would be worth £1,100 today. However, returns have been strong since then: a £1,000 investment in the fund a year ago would be worth £1,350 today.