For someone who flies biplanes in their spare time and has a passion for motorcycles and cars, one would think Mark Northway would relish active management with its high active share. But it’s actually market beta, and an evidence- based approach to investing in particular, that really gets his pulse racing.
Northway is an investment manager at Sparrows Capital, a firm that started life as a family office in 2008, but added discretionary fund manager to its services in 2013. In February this year, it launched a fixed-fee model portfolio service aimed at intermediaries.
Coincidentally, or not perhaps, the range launched on 20 February 2020, which is also the date the new £20 note entered circulation. It has a £20 cost cap and is named Score MPS.
Northway joined Sparrows Capital in November 2015, from a distribution role at Four Winds Capital Management. Before that, he was head of marketing and distribution EMEA at Brookfield Investment Management. This followed trading roles at Standard Chartered, Rabobank International and LBBW.
“We’ve been managing money since 2008, and that actually predates the existence of the firm, which was set up in 2013, and licensed in 2014 in the UK,” he says. “It’s effectively built around the management of family wealth, which was transferred from a variety of investment activities to the evidence-based process we’ve got now. This was in July 2008, of all times, which gave us a baptism of fire.
“That original portfolio was put together by Yariv Haim, our CEO. It means we are probably the only evidence-based investor with experience of both crises, if you include the current Covid crisis.”
An academic approach to investing
The MPS comprises four ranges, each containing 11 factor-tilted portfolios representing equity exposures from zero to 100% in increments of 10%. But rather than pick from the vast array of active managers, Sparrows’ ethos is based on long-term academic-backed evidence, which leads them to passive and index investing.
The firm’s core portfolio, the one launched in 2008, has been managed in this manner since inception. Evidence-based investing is premised on market data and academic studies that identify asset allocation as the primary driver of risk and return over the medium to long term. It has groundings in modern portfolio theory as pioneered by Harry Markowitz.
Sparrows Capital therefore uses index funds and ETFs to build globally diversified portfolios to produce beta. By adopting this evidence-based investing, the firm finds itself in illustrious company, as it’s an approach favoured by two of the largest pension funds in the world, the Norwegian Government Pension Fund Global and the Japanese Government Pension Investment Fund.
Northway says in essence research shows the return an investment gets over time is fundamentally a product of the strategic asset allocation it adopts.
“The way you set out your portfolio on day one will, to a large extent, define the returns you’re going to achieve. Everything around the edge of that is noise.”
Northway alludes to another study by a famed investment academic, Roger Ibbotson, that suggests about 94% of the return is due to strategic asset allocation. This means all the activity around the edge, in terms of active management, market timing and sector analysis, is responsible for just 6% of returns.
“And that’s not necessarily 6% of the positive returns,” he says. “That’s 6% plus or minus around your strategic asset allocation.”
That is not to say the firm doesn’t think alpha exists. Northway says there are undoubtedly managers able to add value over time but they are few and far between, and the cost of accessing their skill tends to eat substantially into the benefit. Furthermore, he says the research involved in sourcing alpha is huge, and describes the feedback loop as problematic “because you only find out your manager wasn’t a high performer retrospectively”.
“If one is paying active managers across the entirety of a portfolio, and generally one is achieving something like 95% beta and 5% alpha, why on earth would you pay active fees? So, what we say is take the 95% and set it aside for high-efficiency beta and take the 5% and put it with an active set of managers in a high-conviction, high-concentration portfolio.”
Most advisers favour a fixed or capped fee model
The MPS costs are priced at 0.1% and capped at £20 a month, which Northway says is based on demand. The decision on pricing came out of a series of internal discussions, but also market research conducted in conjunction with The Lang Cat, which found more than 80% of advisers supported a fixed or capped fee model. The most popular price range came up as £20-30 per month, with 66% of respondents deeming up to £30 as reasonable.
“We have made it a cap rather than a fixed structure, so that for the smaller portfolios it’s just 10 basis points a month, which we think is market-leading. We also believe capping off at £20 a month is market- leading, particularly for an independent company.”
He adds: “What that means is we are not about assets under management, we’re about people under management. What matters to us is not the number of financial advisers we have signed up but the number of clients under the financial adviser that come with that.
“It doesn’t matter to us whether those investors are large or small. Obviously, the value of our position at an investor level increases depending on the size of his or her individual investment.”
But Northway says despite the regulator’s focus on costs, across the industry investors aren’t as conscious of charges as they should be. He feels the industry is overdue “a real Darwinian rationalisation” of sub-par funds.
“If you think about it from a cost perspective, investors are supporting a massive industry and that massive industry is producing near-zero value. One would assume, therefore, that you would get a rationalisation – but you’re not seeing that.
“A lot of that has to do with investor behaviour. Investors aren’t as awake to costs as they need to be; they aren’t as awake to performance as they need to be; and they don’t move assets, for a lot of reasons, when they should be doing so.”
That said, Northway thinks there are signs of consolidation, especially in light of the FCA’s value for money regime, but it is sub-scale rather than sub-performance funds that are being addressed.
“There are barriers to entry to the industry that are quite substantial and, again, this all comes down to pricing,” he says. “The industry is hooked on a drug, which is asset-based pricing, so an asset manager that controls £1bn or £2bn or £5bn has a massive capacity to benefit from the economies of scale across what is very often not terribly interesting performance. What that does is prevent newcomers and creates a huge barrier to entry.”
He adds: “Fundamentally, if people think about their beta and alpha exposure and build their portfolios accordingly, you will start to see a further increase in the use of index-based products, which is an eminently sensible way of managing the core of a portfolio.”
Persisting with value as a factor
The Score portfolios are focused on four factors – small cap, value, momentum and low volatility – based, again, on the idea these are the factors supported by academic evidence. But because value has performed so catastrophically over the past 10 years compared with growth, does that mean the world has shifted to a new paradigm and the value factor has effectively ceased to exist?
See also: Sparrows Capital hires from Netwealth to push MPS
“It’s a very problematic discussion,” says Northway, “because one explanation is that factor is actually now a coiled spring, and over time the pricing of value stocks is set to outperform. The other says we are in a new paradigm and we all need to adjust.”
So, which camp is Sparrows Capital in? “Our reaction to that is very simple: when the academics come to some form of consensus about it, we will react to that, but for the time being history shows us there is a premium associated with that.”
In order to addresses the cyclicality of the four factors, Sparrows Capital mixes them so that low-risk portfolios include a couple and higher-risk portfolios will have all four. Within the range there are two factor- based suites currently available and two responsible investing suites yet to be launched. Both suites have one portfolio comprising index funds only and one with a mix of index funds and ETFs.
The reason for the two options, according to Northway, is some financial advisers are not comfortable with ETFs and some platforms aren’t very efficient around ETFs.
“Our preference for the most efficient way of doing this is to deliver funds and ETFs as a hybrid – but to the extent that someone doesn’t want it, there is a pure funds alternative.”
Cleared for take-off
Either way, all routes come back to passive for Sparrows Capital, and market return using strategic asset allocation is the safest flight path.
In early February, just before the Covid crisis kicked off in the UK, Northway had to return the plane he had a share in to Germany as it had been sold, and as he speaks about his last flight, it’s clear his enthusiasm remains undimmed.
“My first flight was 1973,” he says. “Flying is an absolute passion, I love it.”
When I suggest a passive approach to investing doesn’t necessarily fit with this love of “toys” and speed, Northway points out that all kinds of people become attracted to this approach.
“Historically, that isn’t where I’ve been, but you’ll find an interesting collection of characters here, and I think the people working at, and with, Sparrows fall into different camps.
“There’s those of us, like me, who have come along, taken a look, and said, ‘That’s interesting, and actually very rational’, and they have seen the light if you like. And there are others who have come to Sparrows because they know what’s going on here and it suits the way they have always thought about investing.”
Despite Northway’s obvious focus on the business, it’s clear he’s still itching to get back in the pilot’s seat as soon as possible and enjoy his other passion when he can find an opportunity.
“There is another plane that sits up at North Weald airfield I’m stalking,” he admits, “but I haven’t made it up there just yet.”
