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Exploring Mutual Funds – The Role of the Fund Manager

Ray Calleja

An article written by Ray Calleja: Head – Private Clients, MeDirect

It is the fund manager who, based on research and analysis, makes the decisions about buying and selling the portfolio of securities making up the fund’s assets. Your portfolio of securities can be managed actively or passively. If your portfolio is passively managed, it is based on an established index, and the components are chosen by keeping in mind the underlying index. In case of an actively managed portfolio, the fund manager picks the components of the portfolio. The fund manager plays a decisive role in the performance of active mutual funds.

So, for actively managed mutual funds, the fund manager is basically in charge of what stocks, bonds or other assets the fund will buy with the investors’ money. Essentially, the fund manager will function as a stock-picker. Focusing on price-to-earnings ratios, price momentum, sales, earnings, dividends and other various metrics, the fund manager will build a portfolio of assets to accomplish the aims of the mutual fund. Those aims (growth, value, income etc.) are spelled out within the mutual fund’s prospectus. While fund managers do have some leeway, these aims help the managers refine their search on certain sectors or styles pertinent to the individual mutual fund.

A mutual fund manager also has to keep in mind the reporting standards as per the regulatory guidelines. The building of a fund takes into account the objectives of the investors, the strategies, risks, expenses and various policies. A fund manager is responsible to abide by these details and rules; and has the responsibility to make sure that all the documents are furnished on time and following all the rules and regulations.

In Europe, the Undertakings Collective Investment in Transferable Securihave grties (UCITS) Directive is a detailed, harmonised framework for investment funds that can be sold to retail investors throughout the EU. This means that mutual funds authorised in one Member State can be marketed in another MembAlexander Darwaller State using a passporting mechanism. Originally introduced in 1985, the UCITS rules have been revised several times and are updated from time to time, most recently via the UCITS V Directive which came into force in March 2016. The aim of UCITS V was to bring the UCITS regime into line with the Alternative Investment Fund Manager (AIFM) Directive (for information purposes only the AIFMD applies to managers of funds that are not UCITS including hedge funds, private equity funds and real estate funds) on remuneration and depositary rules and introduce a range of corresponding measures: it clarifies the depositary role, introduces rules on remuneration policies to be applied to key members of the UCITS management company’s staff and harmonises minimum administrative sanctions for infringements to the UCITS rules. There are more than 34,250 UCITS funds in the EU which represent over €10 trillion of assets under management, as at April 2020.

The fund manager has to protect the wealth of the shareholders in a mutual fund. No one disputes the fact that funds are subject to some risks to generate returns, but they must not be subjected to reckless risk-taking. The decision of the fund manager with regards to the buying or selling of assets will be based on extensive research and due diligence. To protect the wealth of the investors, the manager will, if need be, employ investigations into the company in question, use risk management techniques to evaluate the investments etc. To address risk, fund managers have to ensure that there is adequate diversification in asset portfolios.

The fund manager will take a call as to where to invest, and these decisions are governed by regulations, expectations and objectives of the fund itself. Fund managers are judged based on how well their funds perform and how they deliver growth, which is above their benchmark and category.

For larger mutual funds, the lead fund manager is often supported by a staff of analysts, traders and other people who monitor the markets, make trades and perform other duties at the fund. The fund manager will depend on his team within the fund company to handle the issuing  of the annual report, acquiring capital, negotiating with brokers etc. The support staff is critical in making sure the fund operates in an efficient and profitable manner. However, it is the lead mutual fund manager’s job to guide the overall direction of the portfolio. Ultimately, he or she is calling the shots on just what it will own and when.

Sometimes, mutual funds are managed by a committee process. Here, lead fund managers will bounce ideas off of each other and stocks are selected via a vote. Another common approach is a multi-manager fund. Here, each management team is given a percentage of the fund’s assets to guide and are only responsible for that share of the fund. A single lead manager will decide on who will be responsible and how much of the fund’s assets are given to manage.

For index funds, the managers have a slightly different purpose. In a full-replication index, a fund manager’s job is to buy all the equities within that respective index. For example, a full-replication S&P 500 index fund will own all 500 stocks in the index. The fund manager’s job is to manage inflows and outflows of the fund and buy/sell stocks accordingly to continue matching the index. However, not all index funds use a full-replication strategy. Some will only buy most but not all of the equities within the benchmark index. The idea is that the fund will attempt to closely match the overall investment attributes of the index. In such instance, the fund manager’s job here is to buy and sell equities within the index to closely match the sector weightings and provide a large spread of firms to cover the underlying index. This sort of indexing strategy is mostly common in international and emerging market funds.

In previous articles we discussed the various types of risks that are involved when it comes to investing in mutual funds such as market risks, business risk, currency risk, etc. It is particularly interesting to know that a fund manager will have ongoing meetings with the top management of companies he/she will invest in to fully understand the business and the plan of these entities. On evaluating their potential, the fund manager takes a call whether to invest in in one company and not the other, while aiming to deliver alpha to his/her shareholders. This process continues on an ongoing basis and allows the fund manager to continue to monitor the performance of the company he/she has decided to invest in.

They do this with the assistance of an entire team of researchers and analysts who keep a close watch on markets and companies. They churn stocks from the portfolio based on their outlook and reallocate funds to companies that they believe will benefit the fund’s shareholders in the long run.

One of the dilemmas that individual investors face is when the fund manager quits the fund. While the importance of a fund manager cannot be overlooked, it should not send you in a frenzy and an immediate response to redeem your shares in that fund. It is quite difficult to quantify the actual impact on the performance of a fund once a fund manager steps down. There have been several cases when a fund manager’s departure leads to a downturn in the performance of a fund but, similarly, there have been many cases, where a new fund manager brings in a breath of fresh air and the performance of a fund actually improves, too.

You are often advised that when there is a change of a fund manager you should keep a close watch on the fund’s performance for a few months. If the fund performance deteriorates, then you may wish to consider redeeming your shares in that fund. However, fluctuations are common in the market, and a well-managed fund may well come out on top in the long-term. When looking at a mutual fund’s historical performance, be sure to confirm that the manager or management team has been managing the fund for the time frame you are reviewing. For example, if you are attracted to the 5-year return of a mutual fund but the present manager’s tenure is only one year, the 5-year return is not meaningful to be able to make a decision whether or not to buy this fund.

Experience is also key. A rule of thumb is to stick with managers who have at least 10 years of experience. But if a fund manager lacks such length of experience, but has learnt from some of the best fund managers around or has worked, for many years, at fund houses, which have lots of good quality funds, that should still point to a positive outlook.

Fund managers are not isolated individuals, and whether a fund succeeds or fails depends on the quality of its analysts and traders as well as its manager. Quantity is not essential but it would be comforting to know that there is whole organisation behind the manager. The key way of knowing the quality of a manger’s support team is to look at the records of funds from the same firm.

Our partners, Morningstar, publish their Fund Family 100, which is a bi-annual report in which they compare across Europe, the largest 100 investment management firms by assets under management. They rank those firms based on different criteria, including manager retention and tenure, the quality of their fund range in terms of Morningstar Analyst Ratings, and Morningstar Sustainability Ratings, as well as the specifics of their cross-European fund line-up, such as the split between different asset classes, passive and active management, and finally their fee policies. Morningstar also hand out annual awards for investing excellence in three categories: Outstanding Portfolio Manager, Rising Talent and Exemplary Stewardship. The winners of each award demonstrate the industry’s very best attributes, including investment skill, the courage to differ from the consensus to benefit investors, and an alignment of interests with the strategies’ investors. The firms nominated as Exemplary Stewards are ones who have consistently put client interests before their own, yielding better results for shareholders.

All these tools can help the individual investor make an informed decision when it comes to choosing a mutual fund.

Many investors purposely seek out managers with a high-conviction approach. Sometimes these managers take big bets on the businesses they believe will thrive over the long-term. Such managers are often notorious for having incredibly concentrated portfolios. But when these managers get it wrong, the consequences on returns can be significant.

Jon Miller, head of manager research at Morningstar, says: “Managers with concentrated portfolios are by nature making key stock specific calls. Clearly, they’ll be doing something different than the index, meaning the potential upside and downside versus the market can be pronounced.”

But sometimes fund managers do make the wrong call and returns can collapse. For example, Alexander Darwall, manager of an investment trust, described his decision to invest in German payments provider Wirecard as his biggest mistake ever, as he saw around 10% of his assets disappear in a matter of days. He admitted his mistake as he offloaded his stake in the business two weeks ago. Darwall first invested in Wirecard 13 years ago, when shares were around €9, increasing his stake over time, and started to reduce his position in November 2017, when shares hit €121. But concerns about Wirecard have been circling for some time, with persistent suggestions that some of the company’s reported revenues and profits were not reliable. While Darwall reduced his holding in the firm from around 15% of assets to 10%, he continued to stick with the stock. Morningstar Direct data shows that as of 18 June, the trust was the seventh largest owner of the business, with a 0.93% stake. As many readers would know, Wirecard is now considered as beyond saving, with its massive accounting scandal, the arrest of its former CEO and declaration of insolvency just a few days ago.

To sum up, a fund manager plays a vital role in implementing the fund strategy and does his/her best in ensuring both the protection and growth of your capital. That being said, the performance of the fund does not lie solely on the shoulders of a fund manager but also on various market constraints. If a fund manager quits, do not redeem your fund units in haste fearing a loss. Be patient and analyse performance objectively before taking redemption decisions. Nevertheless, the fund manager is one of the biggest pieces when deciding which funds to select. It is he or she that will ultimately guide the investment of the underlying portfolio. By functioning as stock- or bond-picker, the fund manager is responsible for making sure the portfolio is earning a return that is hopefully beating its benchmark and category.

The above is for informative purposes only and should not be construed as an offer to sell or solicitation of an offer to subscribe for or purchase any investment. The information provided is subject to change without notice and does not constitute investment advice. MeDirect Bank (Malta) plc has based this document on information obtained from sources it believes to be reliable but which have not been independently verified and therefore does not provide any guarantees, representations or warranties.

The financial instruments discussed may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in any of the products discussed you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment and may be deducted from the invested amount therefore lowering the size of your investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.

MeDirect Bank (Malta) plc, company registration number C34125, is licensed by the Malta Financial Services Authority under the Banking Act (Cap. 371) and the Investment Services Act (Cap. 370).

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