It’s a well known saying, but none the less often true, that what goes around comes around.
So, after years of underperformance should we be surprised that Phillips & Drew at last comes top of the institutional funds league table. However, it will take a few years of good numbers before it fully makes up the ground lost over the previous three or so years.
Similarly, Schroder Investment Management has outperformed consistently over 2000 after two earlier years of significant underperformance. But for whom should you feel sorry?
Well, just think of the poor pension fund trustees who, after years of underperformance, finally lose patience and sack their value-based manager just as value comes back into fashion. It shouldn’t happen, but it does. Too often the poor performing manager is sacked and replaced by a manager just about to perform poorly. In 1999 those poorly performing managers were often replaced by index managers just when the index was not an attractive place to be.
A good example of the dangers posed by slavishly following an index currently being brought to the attention of trustees is the case of Dimension Data.
On September 15, this South African-based company joined the FTSE All-Share Index and indexers chased the stock from 650 pence all the way up to 1000p at the close and the price at which the stock entered the index.
Of course, the following day the stock moved straight back to its true value of 650p. The indexers that bought at close of business on September 15 did not lose relative to the index but any rational person would accept that pension fund clients have hardly been well served. Indexers who did not buy at the inflated price made money for their clients but introduced a serious tracking error that has to be explained to clients. Critics claim that it is no place of an index manager to gamble with a client’s money, but does it really make sense to slavishly follow an index.
As Nick Fitzpatrick of consultants Bacon & Woodrow so elegantly puts it: “Choosing a benchmark is an investment decision.”
So we should all take more care when selecting the benchmarks we want our funds to be judged against and take particular care when selecting index managers. Just possibly, tracking errors may be signs of good judgement being used. Pension funds have to use their own judgement when selecting managers but sacking managers who have wide tracking errors or who have just performed badly in order to pick perfect index trackers or managers at their peak is rarely a successful strategy.
One strategy currently receiving favourable reviews is enhanced indexing. It has been around for a long time. I seem to remember Japanese managers using it quite successfully in the mid to late eighties. However, since then Japan has been one of those few countries where even poor active managers have consistently beaten indices. Over the past 10 years, according to CAPS, lower quartile managers have beaten their benchmark index in Japan by nearly three percentage points.
However, if slavish indexing becomes rather suspect as a strategy, enhanced indexing could well be in for an increase in support. The main quantitative managers, such as Barclays Global Investors, have offered enhanced index strategies for some years but now active managers, such as Merrill Lynch Investment Managers, have started to offer the strategy in Europe.
So what is enhanced indexing? According to Merrill Lynch, simply a strategy whereby quantitative stock selection and stock substitution techniques are used to exploit predictable market anomalies to achieve superior risk adjusted returns. I suspect such a strategy, which may well work well now, might have difficulty in continuing to produce the goods when rather more money is managed on the same basis.
As usual the rewards will probably go to those who adopt the strategy early rather than those who wait for it to prove itself.
How should a pension fund react to extreme political pressure? Without wishing to make any judgement about Huntingdon Life Sciences (HLS) – the UK research laboratory that tests on animals, I am very concerned that the institutional investment community is being perceived as giving in to coercion by political pressure groups, in this case animal rights protesters.
It started in January 2000 with the UK’s ruling Labour Party’s own Superannuation Fund telling its fund managers to sell all its shares in HLS. Then a leading fund manager was reported to have dumped its holding under pressure.
Now we have reports that at least one of the world’s leading custodians has withdrawn its support for the pharmaceutical testing company as a result of being targeted by animal rights protesters. If this is true and banks are refusing to act as custodians for their clients who hold shares in HLS because their staff have received threats, I can only echo the sentiments of the managing director of HLS that “if financial institutions cave in they will only encourage terrorism”.
As animal testing is required by law to prove drug safety these decisions may appear socially irresponsible investment actions. I can understand the actions of such banks, but one has to ask: where will it end?
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