The View from the Abyss

What’s it like holding — or managing — a fund that’s passing through Hell?

I prefer to invest with active fund managers who are on a heroic journey. This isn’t because I enjoy grueling challenges, far from it: The closest I get to endurance sport is having to sit through Eurovision. It’s because I believe these are the managers who will make the highest long-term returns.

By ‘heroic journey’, I mean that, because they’re fully swinging the bat, and they usually specialise in one tightly-defined approach, their fund management career will be full of dramatic peaks and troughs.

As such, while they might average 3% a year over the market in a decade, they won’t neatly achieve that for each of those ten years. Instead they’ll have a few years when they’re, say, 20% ahead, and others when they’re 10% behind.

This makes their funds hard to hold. Not because of the peaks — obviously they’re wonderful. It’s the troughs — they’re emotionally challenging and, at their nadir, can trick you into losing money by abandoning a great fund just before it rebounds.

I call this ‘The Abyss’, and all fund management legends have passed through at least one in their career. What’s it like?

As a fund of funds manager, I’ve experienced this from both sides — as holder and manager of a temporarily underperforming fund, so I can speak about both.

I asked the same question to a couple of UK equity value managers too. They’ve experienced an abyss (value underperformed) within an abyss (UK equities underperformed), so their insights here are timely. Coincidentally, I spoke with one of them — Kevin Murphy — just a few days before he quit his 24-year stint at Schroders to join a start-up value boutique — Brickwood.

The first thing to note about the abyss experience, as Murphy pointed out, is that they’re not all equal. They can vary in many ways, but the two key differentiators are direction and timespan.

Direction first of all. Murphy described the experience of his fund underperforming a rising market as “painful but manageable”. I can echo this from a fundholders’ perspective: It’s frustrating to see a fund pick lag in a rally, but I’m still making money, not losing it, so the need to ‘fix’ the situation isn’t as urgent.

Underperforming a falling market is different. The ‘don’t just sit there, do something!’ syndrome kicks in sooner, as your clients, your colleagues, your bosses, and even your own inner voice urge you to make this costly situation to go away — quickly.

Many do change course. For the fund manager, this might mean the cardinal sin of abandoning your style and process. If they get this wrong, they’re toast. If they get it right, they’re probably toast too, but at least their holders will be smiling on the way out.

For the professional fund holder, abandoning the fund may or may not work. If it works, it will appear in the next client update as an inspired call. If not, it will be swept under the carpet, never to be mentioned again.

The second big variable is timeframe. Basically; a quick abyss is a different beast to a drawn-out one.

Take Baillie Gifford in the 2020 pandemic sell-off. We now know this was one of the shortest bear markets in history, but it was alarming at the time. Particularly if you were holding Baillie Gifford American. At the nadir of that flash-abyss, this fund was down 29% from its peak, fully 10% more than the market’s retreat.

Underperforming a falling market is normally a nightmare for manager and holders alike. But this one happened, and reversed, quickly: So despite the plunge, there were few sellers, and within months money was flooding back in.

But if the fund had generated the same performance over 25 months, not 25 days, it would have been a different story.

Why?

It’s the grind. We fund buyers are full of grit and confidence in the first few months of underperformance. We’ve done the work, we know the fund, so any questions can be safely repelled with a swift “don’t worry, it’ll bounce back”.

If it does rebound, like Baillie Gifford American in 2020, then great: We look like a sage. But if it keeps grinding lower, then lower, then lower, stretched over the nine quarterly review meetings of a 25-month abyss, then “it’ll bounce back” starts to wear thin.

As it does, the pressure to ‘do something’ grows, to the point where, even if the rational Spok-like part of our brain tells us to stay put, our emotional Captain-Kirkial lobes tells us to run for the hills. And as any Star Trek fan knows, Kirk usually pulls rank.

However, in my experience, more often than not Spok’s right. Which makes the anti-adage of “don’t just do something, sit there!” a better rule of thumb. But financial, corporate, and emotional forces usually prevail. This means that perhaps the biggest source of outperformance, for both fund holder and manager, is finding the resilience to withstand this pressure.

How?

Both Murphy and the second UK value manager I spoke with, Adam Rackley of Cape Wrath, arrowed in on one factor: The option, and ability, to separate work from home life. For both, reimmersing into their families on evenings and weekends provided invaluable breathing space.

Rackley, by the way, is no stranger to feats of resilience — many of which go beyond even an evening of Eurovision: He has swum the channel; cycled Britain; and rowed the Atlantic. But he admits that, in the depths of his fund’s abyss (late pandemic), he came closer to shutting his fund than he had to quitting any of those more physical endeavours.

Thankfully he didn’t, as his fund has been a post-pandemic star: It’s rallied more than 90% since the day the vaccine news broke late in 2020, comfortably outperforming his peer group.

This highlights another quality needed to beat The Abyss: Character. Fund management is endurance sport for the ego. So, if you’re planning on managing, or buying, a highly active fund — make sure you’ve examined your own character as well as the manager’s. It’s no job for flakes.

Finally, your scaffolding is crucial too: Too many C-Suites have a nasty habit of pressurising the manager in their hour of need, not supporting them. This only deepens the abyss, thereby raising the chance of failure, not lowering it.

Will this ever change?

I suspect not — it’s too ingrained in human behaviour. Thankfully there are always exceptions. And as fund buyers, we must not just find them, but be them too.