Neptune sidesteps shackles of benchmarking
11 March 2013
By Toby Garrod
As the cult of passive investing reaches ever-new highs, a significant vacuum is developing in the genuinely active space, as benchmarks increasingly come to define the peripheries of what fund managers feel comfortable doing, say some market players. UK-based investment boutique Neptune Investment Management is working to counter such trends, catering to those investors who understand that real investment risks need to be taken to achieve returns significantly beyond those of managers seeking to achieve index-plus-one results. As such, its funds perform in a very different way to most of its peers.
“I’m perhaps showing my age here, but when I started investing, you never talked about benchmark or risk, because the contexts were unknown,” says Douglas McDowell, Neptune’s head of client investment strategies. “Was it risky? We didn’t know. We couldn’t measure it against anything. A portfolio might rise 25%, but the investor had no idea whether that was good or not compared to any benchmark. One of the unfortunate consequences of learning about lots of stuff regarding measuring and benchmarking is that bizarrely, with more information we have become less risky. Because people are suddenly thinking, ‘what we are doing is risky, as it turns out. We never knew it before. Let’s not be risky’. I think this has led to people becoming more cautious, producing sub-optimal portfolios and not maximising returns.”
Mr. McDowell also notes that using benchmarks to determine investment allocations means relying on the problematic assumption that past data is a good source of information regarding future performance. Those investment firms that had large allocations to Japan in the 1990s simply because Japan represented a significant portion of the MSCI World Index will have been badly burnt, he notes.
“In contrast, rather than reflecting indices and benchmarks, our distributions geographically are increasingly a consequence of listings. In our global equity fund two or three years ago, for instance, we had quite a lot of money in the UK, but it was SABMiller and BHP Billiton. These were UK quoted businesses that had absolutely nothing to do with the UK domestic economy, but were broadly exposed to global growth trends [in China, for instance]. In the same way, up until recently we had quite a lot of money in Japanese internationals, despite the fact that the Japanese economy is terrible.”
Perhaps more worryingly, alongside the ranks of managers that are moving into the passive investment field, there’s a fairly significant group that are claiming to actively manage (and charging for it), but are in fact active in fairly limited ways, says a May 2012 report from Pimco titled ‘Equity Investing: From Style Box to Global Unconstrained’. The increasingly constrained and risk sensitive investment environment may have been the catalyst for managers to ‘play the game’ and become benchmark oriented, it says, asserting that many active managers have recognised that assets and revenues were at risk if they deviated too far from the benchmark, and so they became ‘closet indexers’.
“We know there has been an increase in passive investing – but surprisingly, assets in closet indexers have grown at an even higher rate, such that closet indexers today represent approximately one-third of all US equity fund assets!” says the report. “At the other end of the spectrum, assets in highly active managers, who tend to invest based on research conviction and do not have a benchmark orientation, have declined from 60% of overall fund assets to less than 20% today. In other words, it is easier to find managers that are benchmark constrained than managers that are highly active.”
As such, Neptune and Pimco perhaps represent the tenacious group of firms that have remained unclouded by the rising global fog of passivity.
“Our process allows us to understand the operating environments of all the sectors and subsectors in our available universe, and from that make judgments about where we think growth is going to be driven from,” says Mr. McDowell. “A portfolio to us is simply a collection of businesses. As such, primarily we are business analysts. We try and understand the operating environment that the company is in, and whether or not they are going to be beneficiaries of what we see as the key drivers to those sorts of things. We populate our portfolio with those businesses that our sector research tells us are likely to be the prime beneficiaries of those broad trends.”
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