Investment markets have been through the mill in 2020 reacting to the Covid-19 pandemic, going from blasé, to panic, to recovery and even euphoria. Asset owners could be forgiven for a sense of confusion here, but does underperformance over this period help us decide whether to terminate a manager?
"My view is that you should cut your underperforming active manager some slack and be tolerant of any underperformance over the first half of 2020. Covid-19 was a truly random event and largely unforecastable; reacting to, even significant, underperformance may not be your best course of action."
Satatium voloration pos volorem aut inuscip santur sa endignis etus, coruptatia aut fugiatis aut occullu ptatem que num exped quia volorerestia nectem a sequia et autatis. Nostiam es egi aleris noxim me vernica vividi menius in etiquam. Nostiam es egi aleris noxim me vernica patquodiu simissoliis nectem a sequia et autatis.
Satatium voloration pos volorem aut inuscip santur sa endignis etus, coruptatia aut fugiatis aut occullu ptatem que num exped quia volorerestia nectem a sequia et autatis. Nostiam es egi aleris noxim me vernica vividi menius in etiquam. Nostiam es egi aleris noxim me vernica patquodiu simissoliis nectem a sequia et autatis.
Unforecastable randomness
The events of the first half of 2020 were largely unforecastable, entirely random and had highly disparate effects on different parts of the economy. Who would have thought we’d see negative oil prices – an unprecedented event. It is only with hindsight that the full market implications could be called inevitable.
So, did any sectors/investments do well? Tech companies, especially those that facilitate online living and home-working, have prospered, and healthcare companies have generally thrived. And some individuals did well financially too, Amazon’s Jeff Bezos added another $24bn to his wealth!
In US dollar terms, global energy stocks were down nearly 35% as a group (to 30 June), financials have lost nearly 25%, but technology stocks are up nearly 15%, and healthcare has managed a respectable 4% return. This represents a huge sector dispersion.
The gap between the best and worst performing sectors is larger than it has been since the global financial crisis and in the widest 5% of six-month periods since 1973.
This story is repeated when we look at managers – with the gap between the managers that fared best, and those that have fared worst.
If your manager was positioned in the ‘right’ sectors, it’s likely you experienced a welcome outperformance. If your manager was positioned in a different way, it’s likely you’re sitting on disappointingly large underperformance. Even relatively small differences in position - taking has led to larger than usual differences in performance.
The difference in performance between equity styles has also been exceptional. Value stocks – those with higher dividend yields, lower price to book and earnings ratios, which include many energy, financial and airline companies, – have underperformed growth stocks by over 20% to June 30th.
This phenomenon of large disparity of managers’ performance is not only true in equities. Corporate bond managers and multi-asset managers have also had a widespread of returns for the same underlying reasons: Covid-19 has affected different parts of the markets and the economy in wildly different ways.
So what should you do if you have a manager that has been the wrong side of these effects and has suffered a significant underperformance?
It takes many years of track record to give anything like convincing evidence of skill and a relatively short, six-month period is just a mere data-point in that evidence. I think the first half of 2020 has been a particularly insignificant one, even for a large magnitude of out or underperformance as it was entirely unforecastable.
This period is too short and too random to justify replacing a manager, but if it came after a longer period of poor performance it may be the catalyst for a change. I argue that even in this situation, investors should be very tolerant of underperformance and shouldn’t rush into replacing a manager that has disappointed.
Equally, in a few years’ time, if this period was the start of a period of underperformance, I would largely disregard it from the track record for the purposes of deciding if the manager’s performance is up to scratch.
No rule is absolute in investing. I think there may be an exception to performance over 2020 being largely random: energy stocks have been under pressure from falling oil prices for some time now. The price of oil may have been affected by lockdowns imposed to combat Covid-19, but this was just another stumble in a multi-year downward trend. With hindsight, perhaps we can see that bigger picture and we might expect a skilled manager to have spotted it in advance? Managers that have underperformed due to a holding oil and energy stocks perhaps deserve a little less tolerance.
Being blunt, the capital lost from the underperformance is gone, you should have no reason to hope that it will return. This is tough to take, but is an important point to accept it to try and free you up to make the right decisions. The decisions you make now affect only the future. Look at the reasons you selected the manager in the first place, if the thesis that the manager has is broken, then replace it; but I think you should try to disregard the level of performance in 2020 from this analysis.
There is often useful information in a performance track record over and above the level of performance. It can be evidence of whether or not a manager has followed its stated process. This more nuanced analysis may, of course, help you decide on a manager’s continued appointment.
The obvious corollary is that you shouldn’t give much credit to a manager that has performed well over 2020 either. If you were close to replacing a manager and now think it has been ‘saved’ by outperforming over 2020, you should perhaps ignore the recent track record for similar reasons – 2020 has been a year of more than usual randomness.
Keep in touch
