When the portfolio manager of a fund leaves, it is natural to be concerned. After all, you may have specifically recommended the fund to access that manager’s knowledge and expertise. If he or she moves on, the fund could become quite different; which is not always a bad thing. Although some manager changes are a negative for unit holders, in other cases they improve the fund.
The big question, therefore, is how to gauge whether the impact of a change is good, bad or neutral? It’s impossible to know for sure, of course, but there are various things to look for that can provide a good idea of what to expect. Here are some key issues that Morningstar fund analysts consider when a manager departs.
Importance to the Fund
Not all portfolio managers are equally important to the funds they run. Some are absolutely central and difficult to replace; if a key manager leaves, it’s probably time to get out. For example, consider Greg Perry, who left Colonial First State in 2002. Perry built up an enviable reputation running the Imputation Fund but since he left the fund has had a raft of changes and numerous portfolio managers and has only been an average performer, relative to the market and its peers, despite a market environment particularly favourable to its growth-oriented investment style.
The nature of some funds, however, makes their manager less crucial, even if he or she is very good. In contrast to research-intensive offerings, index funds tend to be less reliant on individual portfolio managers, so when one of them leaves, it’s usually not too big a deal. Vanguard’s International Share Index Fund officially got a new manager in June 2007, when Roger McIntosh stepped away from equities and was replaced by Alla Kolganova, which caused little concern here at Morningstar. The fund’s main attraction is its low cost, which did not change. Also, McIntosh is still with the firm (he’s now Head of Fixed Interest), and Kolganova had been with Vanguard since 2000 and was already Head of Australian Equities. In general, if a manager leaves an index fund, you probably don’t need to sweat it.
Another factor to consider is the smoothness of the transition from the old manager to the new. In a worst-case scenario, a portfolio manager leaves abruptly, with no advance warning, and takes with them all or most of the fund’s analysts and other support staff, leaving the fund manager scrambling to find replacements. Such disruptions greatly increase the uncertainty around a fund.
The departure of INVESCO’s Head of Australian Equities Rohan Walsh and Investment Manager Luke Sinclair in March 2007 are good examples of people departing and leaving chaos in their wake. INVESCO had built up a solid domestic equities business under Walsh – one of the longest-tenured portfolio managers in this asset class – who had established an impressive track record over the longer term. Other departures have since followed and INVESCO has experienced massive outflows, demonstrating limited succession planning by INVESCO senior management, with no apparent ‘Plan B’.
On the other hand, gradual, well-planned transitions where the fund doesn’t miss a beat often make it worth investors’ while to stick around.
The disruption can be compounded when a manager change is accompanied by a complete overhaul of the fund’s investment strategy. It’s not impossible for such wholesale changes to be positive, but experience has made us quite skeptical in most cases.
Advance’s international shares strategy is a good illustration of a new manager adopting a new approach. The firm did away with Morgan Stanley in April 2006, bringing in The Boston Company to manage global equities. Boston’s fundamental approach is very different from Morgan Stanley’s. Boston’s analysts look for companies with the ability to deliver stable and sustainable earnings, with earnings growth a big factor here. Morgan Stanley, on the other hand, places strong emphasis on valuation, in particular on measures such as price/free cash flow and price/book ratios. The result of the change is a different underlying manager, with a different approach, and a portfolio that will exhibit different performance characteristics. BT’s Core global share strategy and Colonial First State’s global share strategy are other instances where a change in manager has led to a distinctly altered approach to managing international shares.
A problem is that changes can turn a fund into something new, which may no longer suit the needs of your client. If you select a large-cap value fund to play a specific role in a portfolio and it suddenly changes into a large-cap growth fund, the portfolio may become skewed in ways not intended, nor desired.
Ultimately, one of the most important factors in evaluating a portfolio manager change is the quality and track record of the new manager. An accomplished manager can make a mediocre fund look good, or a good fund look even better. A new manager with a so-so record, no record at all or untested as a lead portfolio manager, usually gives us pause.
Credit Suisse provides an interesting example of the latter. The Australian shares fund strategy has been through numerous makeovers in the past five years and never really been able to hit the mark. In May 2007 the firm appointed Stephen Giubin as its new Head of Australian Equities. Giubin had been second-in-command at Schroders before taking up the new role at Credit Suisse. While he has a solid background at investing, with over 20 years’ experience in the markets, he’s yet to demonstrate how capable he is at building and developing a new team. We rated Giubin highly when he was at Schroders but he was supported by a well-resourced team and a very capable leader, so we’re not rushing to make a judgment just yet.
Sometimes a change can be a positive for a fund, when an experienced portfolio manager with a great track record replaces someone less accomplished. Crispin Murray’s appointment to run BT Financial Group’s Australian share investments from January 2003 illustrates this. Murray was not well-known to Australian investors, but had earned his stripes running European equities. Murray has quickly established a credible track record in what had been a struggling domestic equities offering. However, one great manager replaces another only on occasion. Much more frequently, the departure of a strong manager is bad news for investors. The situation that tends to make us most wary is when the new manager is an analyst with little or no portfolio management experience.
As all these examples show, evaluating portfolio manager changes is no simple task. It’s impossible to know exactly how a change will work out, but it’s usually possible to get a pretty good idea of what to expect. And it is always a good idea to keep potential tax consequences in mind. If your client sells, he or she may be liable for capital gains taxes, so it is important to find a replacement fund that’s good enough to overcome any potential taxes. In many cases, the best course of action may be to stay put for a while to see how well the new manager does, and recommend selling only if you have really lost confidence.
David Kathman is a fund research analyst with Morningstar, Inc. in Chicago. Chris Douglas is a fund research analyst with Morningstar in Sydney. Neither analyst owns units in any of the funds mentioned above.