The thinking behind this is to take the fund manager back to an index-neutral position and lower the chances of him getting so far behind the market he cannot recover.
The problem with this, from an investor’s point of view, is that it locks in the underperformance because the fund is unable to outperform the index and claw back its losses if it is mirroring that same index.
From the product provider’s perspective it protects the relative track record of the fund, but for investors absolute performance is ultimately more important.
Background pressure
“The conversations tend to go on behind closed doors,” David Coombs, Rathbones head of multi-manager investments, says, “I have seen a manager who is behind benchmark in turbulent markets get told by the CIO to take all relative risk off the table until things are more visible.”
It can be hard to prove, but Coombs says he has his suspicions regarding some changes made to the Janus US All Cap Growth Fund last year.
Former manager John Eisinger was taken off the £459m fund last August having run the strategy since 2008, which Coombs believes was due to underperformance. Indeed the fund had fallen 11.8% in the year to the end of July last year, compared with an average return of 3.8% from the IMA North America Sector, according to Morningstar.
Coombs adds: “A new manager was brought in who cut all the risk in the portfolio and underperformance was locked in, so we sold it. You could argue they put the product first before the investors.”
But are there times reverting to the index is acceptable?
Time is right
Marcus Brookes, head of multi-manager at Cazenove Capital, says if a manager has had a good run in a sector he has taken an active overweight in it is perfectly acceptable for him to cut his allocation and go back to a benchmark weighting in order to take his profits and protect them.
Then there are style considerations. Perhaps if a manager believes his style to be going out of favour he will go back to the benchmark until the market conditions prove fruitful for his approach.
But the result of this could mean the fund is tricky to allocate to, and if you have bought a fund because a manager is particularly well-known for his style you are likely to be fed up if he steps away from this.
Brookes agrees that in many instances the very worst decision a manager can make is to return to benchmark-neutral positions when he has underperformed. This may well take him back into all the sectors and stocks that have just done very well, which, if he has underperformed, he probably wasn’t holding.
Harmless ‘huggers’
Wealth manager Gary Reynolds, CIO at Courtiers, has a fairly ambivalent view on “huggers”.
“If you have a benchmark and you have not got positive views you might as well ride with it. What else is there to do?” he asks, “I think if the hugging is an active decision there is a big difference. I would rather a manager did that than back something he had little conviction in.”
Picking high-conviction fund managers could itself be a form of defence from benchmark huggers. Likewise, quantitative screening should weed out the underperformers who are deemed most likely to move back to the index in a damaging fashion.
Another preventative measure is to ensure regular meetings with managers, particularly if they have gone off the boil slightly.
Whenever a fund has underperformed Coombs increases the number of meetings with the manager and keeps a closer eye on the portfolio to make sure the bets the manager had on are still there and testament to his conviction.
“I do not think any manager is going to send you an email to admit they have moved back to benchmark. It is up to you to be on high alert for it,” he concludes.
Have you ever suspected a manager of reverting to benchmark to protect his relative performance, hurting your clients’ investment returns in the process? Let us know below…
