By Dan Hallett, CFA, CFP
There has been a recent flurry of changes in mutual fund lead managers. This is partly the result of industry consolidation – as managers become disenchanted with asset-gathering behemoths. In other cases, money managers want to scratch their entrepreneurial itch and strike out on their own. Whatever the trigger, change is a fact of life. And money managers turn over on a regular basis. Here is a quick run-down of recent moves.
In late February, Bradley Radin stepped down from his duties at Franklin Templeton, most notably as lead manager of its Global Smaller Companies mandate. Just a month ago, Invesco Trimark announced that small cap manager Ted Chisholm would be leaving to rejoin former colleagues at EdgePoint. Fidelity’s Team Canada has lost several team members over the past several weeks.
One of them is rumoured to have joined former Fidelity Canada CIO Bob Haber’s Trilix Capital. Two others (Bob Swanson & Brandon Snow) have joined former Fidelity manager Alan Radlo, at CI’s Cambridge Advisors. And the rumour mill is actively talking about still more movement but we won’t mention names at this point. Suzann Pennington recently announced she was leaving Mackenzie Saxon to take on a bigger challenge at CIBC Asset Management. Finally, CI recently ended its long-term associations with Trilogy Advisors (Bill Sterling) and Legg Mason Capital Management (Bill Miller).
Whatever the situation, advisors must develop a disciplined framework and process to deal with such changes, which will always happen. To help in this regard, here is a four-step process that we have used over the years for evaluating manager changes and choosing a course of action.
1. Classify the change
When a change happens, you must decide if the change in lead manager is ‘major’ or ‘minor’. A change is major if the person or people departing were primarily responsible for the past success (or failure) of a fund or mandate. This speaks to the toughest part of our job – distinguishing luck from skill and the attribution of skill between firm and individual. When a sub-advisor leaves or is fired – such as when AGF fired Harris Associates in 2006, just four years after hiring them - that is always a major change. By contrast, when one individual leaves a firm – such as Brad Radin’s recent departure from Templeton – it is often more minor.
This classification is highly subjective but it helps to understand how a firm is structured and how decisions are made. For example, when Alan Radlo left Fidelity a few years ago, we viewed it as a major change. While this was a scenario where giant Fidelity lost one person, we viewed Radlo’s influence over funds like Fidelity Canadian Growth Company as very significant. So, we classified that as a ‘major’ change. By contrast, Brad Radin’s recent departure, while significant, is what we’d classify as a ‘minor’ change because of Templeton’s structure and how stocks are selected for their funds.
In a more general context, some academic research estimates that 70% of past performance belongs to the organization. Many others attribute nearly all of a fund’s past returns to the individual in charge. In my experience, it’s too difficult to generalize. This assessment can only be done well on a case-by-case basis.
2. Assess new manager
This is critical step should zero in on three key items: a) the merits of the new or incoming manager; b) similarities and differences between the new and departed managers; and c) an assessment of which manager fits best in the portfolio. The third item assumes that the departed manager is still accessible through another product – often not the case immediately. This can be a tricky assessment, however.
Managers that are terminated typically have suffered a performance slump, which raises the likelihood for the departed manager to be viewed as inferior due to recent underperformance. On the other hand, managers that leave – as Brandes did in 2002 – are likely to do so when their process execution is firing on all cylinders. In this case, there is a good chance that many investors and advisors will follow the manager that walked away. There are no quick and easy tips to avoid making decisions based purely on past performance.
For instance, in 2006 we wrote a report supporting the idea that AGF should keep Harris Associates on its AGF Global Value fund. We argued that Harris’ underperformance at the time was driven by weakness in its U.S. picks and constraints of the AGF fund that didn’t exist on its own global portfolios.
3. Identify a preference
In deciding whether to sit tight or follow the departing manager, a preference between the two must be determined. In the end, this decision will be made with a big dose of subjectivity because the future is inherently uncertain. Continuing with the AGF-Harris example; while we liked both firms, we highlighted that AGFIA’s strong outperformance over Harris at that time was unlikely to be sustained; and that Harris was the better choice over the subsequent 5-7 years.
In other words, when we identified the sources of AGFIA’s outperformance and Harris’ sub-par results, we decided that the differences were temporary – not the result of Harris lacking skill or AGFIA being that much better. In fact, since being fired by AGF, Harris’ global portfolio has outpaced AGFIA by 400-500 basis points annually when equating MER levels and currency.
In many other instances, the choice will be between the new manager vs. another competing manager and mandate – but the same analytical framework applies to such comparisons. In the end, a preference for one manager and mandate must be determined, leading either to a decision to stick with incoming manager or move money to a new manager. If the final decision is to move, there is one more step required.
4. Quantify exit costs and choose a course of action
The most common costs of moving are selling fees (i.e. trading costs, redemption charges) and income taxes on realized gains. I generally don’t worry about deferred sales charges if they’re under 3% or if the difference in fees alone can recoup any exit fees within a couple of years. As for tax consequences, the year 2000 stands out as a painful reminder that investment decisions should not be purely tax-driven.
I can recall meeting with several clients in early 2000 to urge them to sell (or trim) their technology holdings. Granted, I had been doling out this advice for several months but the timing for these folks turned out to be rather critical. But so few followed my advice because of the huge tax bill that would have resulted from selling technology holdings. That advice was directing clients to a change in strategy. By contrast, most manager changes don’t involve such a drastic difference between the ‘old’ and ‘new’ investment.
It may be worth carrying the ‘exit cost’ calculation a step further. Quantifying the return difference needed to make up the tax bill will help put the situation in perspective, though it’s always tough to trigger a tax bill for the possibility of better performance. In other words, because of the costs of moving, the new manager will have to outperform the ‘old’ manager to make the move worthwhile.
For example, consider a situation where an investor in a 46% marginal tax rate holds a fund has a 50% unrealized gain. And suppose the fund you’re pulling money from returns 7% per annum over the next five and ten years. The new manager to whom you’re moving need to generate total annualized returns of 8.72%/yr over five years or 7.86%/yr over the subsequent ten years to make the change neutral over those respective time periods. So, the lower the costs of selling and the longer the expected holding period, the lower the required outperformance of the new manager.
Using this framework will help get you through what are surely very tough decisions and provide a consistent discipline to deal with future changes.