Why you’ll never invest like a fund manager

If there’s anything that comes close to rivalling my obsession with investing it’s cooking.

I even started a supper club with my partner a few years ago which I’m hoping comes back to life this year.

But I still cringe at how ill-prepared I was for the whole thing.

Turning casual cookbook-browsing over a coffee on a Saturday morning into a full tasting menu wasn’t as straightforward as I had expected.

And if you’re thinking ‘well...duh’ you’re absolutely right.

I was insanely naive and there were a million things I didn't know I didn't know, until they went wrong.

I realised very quickly there are reasons this industry is run by professionals.

There is very much a place for amateur enthusiasts but I’ve concluded the actual hospitality sector is run exclusively by highly skilled Duracell bunnies.

And while I focused on the Youtube videos on mirepoix and paused Great British Menu to make notes, I still had no idea of the intricacies of running a proper service.

Practice makes ok, experience makes perfect

There are lots of tips you can take from the pros but it’s what they have to deal with behind the scenes that separates the average person’s world from theirs.

Investing is no different.

Here are five things professional fund managers have to factor into their decisions that we don’t, and a few ways we can use them to our advantage.

1. Career risk

Picture the scene. You’re running a multi-billion pound portfolio of other people’s money and your bosses are expecting strong risk-adjusted returns from you, at least in line with the index.

You spot an opportunity that you think will produce good returns and it looks like none of your peers have seen it yet.

The only issue is that it’s a firm in trouble and there is every chance the turnaround story doesn’t play out like you hope.

Do you:

Invest and spend every second knowing your manager’s eyes are boring into the back of your skull?
Pass up on it to be safe, knowing something less controversial is bound to come along?

This is a very real and very common dilemma for value contrarian fund managers.

Swimming against the tide isn’t always about doing something different than other investors - it can also regularly be about doing the opposite to what your own bosses would do.

And if you think that might not be worth putting your career on the line for, you’re more likely to just invest like the crowd and blend in with the others.

At least then if you’re wrong, so is everyone else. Safety in numbers and all that.

When you run your own money, the only person you have to justify your actions to is you.

And taking skill, experience and the rest out of it, the freedom to invest where you see fit is a tremendous advantage.

2. Justifying decisions

On that note, there’s a bigger picture around defending investment decisions in the professional world that most of us don’t see.

And it has to do with the evolution of the methods we use to determine good investments in the first place.

When information wasn’t so widely available and businesses were often simpler to understand, basic balance sheet arithmetic and straightforward cash flows were an investor’s bread and butter.

Then it became all the rage to be a human computer, constantly crunching ever more detailed data sets and ignoring anything that wasn’t in a spreadsheet.

And you can actually see that difference when you talk to fund managers of various ages - a bit like taking a cross section of the earth’s crust.

Old hands will certainly point to the building blocks of reliable earnings streams, solid management and robust balance sheets but, unlike their younger peers, they’ll often add in qualitative measures too.

Murray International manager Bruce Stout once told me there often comes a stage when science becomes art.

It can make those glued to processes nervous but for him, that’s when you have to rely on your experience and knowledge to kick in.

The difficulty comes in justifying those decisions just in case they go south. Falling back on promising numbers is one thing, putting it down to experience doesn’t always pass the test in 2021.

While that’s not something we’ll run into in our personal investments, I do like the idea of this pre-mortem thinking.

Being able to justify why you’re making a decision before you’ve made it will make you more content even if it doesn’t work out as planned.

At least there was a solid logic to it and you can learn from whatever happens.

3. When risk controls become straitjackets

“Run your winners” is a common aphorism in investing.

But fund managers can’t always do that.

To stay in line with Investment Association guidance or their firm’s rules they often can’t hold more than 10% of their portfolio in any one company.

Of course, that helps ensure diversification but it can also be a bit of a headache if that one stock shoots the lights out.

Managers can find they begrudgingly have to sell quite a bit of their top performers to stay inside the lines.

It’s nearly like they are penalised for getting it right.

And then there’s the balancing act open-ended funds run into. They usually have to keep some of your cash to one side to meet any unexpected customer withdrawals.

While a bit of dry powder can be a good thing to take advantage of market blips, you don’t want to pay a manager to hold cash.

As I’ve said before, cash drag is a real thing and can hold back your gains over the long term.

4. The Goldilocks problem

Sometimes, as a fund manager, your fund gets so big that you can only really invest in big companies.

While that might be the result of your strategy proving popular, it throws up a couple of problems.

One is that when you go stock shopping you run the risk of pretty much buying smaller companies outright. That’s because you’ve got quite a bit of cash in your pocket to deploy.

Of course, you don’t need to shell out a huge amount every time you invest but if you’re constantly making small investments, they’re unlikely to really make a big difference to the overall fund’s performance.

So what if you’re running a ‘smaller companies’ fund?

Well that can mean you simply have to invest small amounts, which ends up in a huge portfolio that’s hard to keep track of.

It’s another issue we rarely run into in our personal portfolios.

We don’t have to balance our high conviction stock choices with that 10% limit and when we see an opportunity we like we can go for it.

5. Perpetual motion

Fund managers always have the long term in mind and the companies they work for have even longer, verging on infinite, time horizons.

That can be a real comfort to investors who want to know their money won’t be used to target short-term speculative gains.

But it also doesn’t take into account our personal investment goals.

This is one real difference between us and the pros - we eventually do want to use that money.

That’s why we need to factor our aims into our specific investment journeys and change our asset allocation as our goals get closer, or change themselves.

It’s worth pointing out that all of these checks and balances are put in place to help protect the everyday investor as much as possible. They aren’t just added in to make the whole thing a bit more challenging.

But the good thing is that we can make use of them as much as we like and do it ourselves where we don’t want a fund manager involved.

For me the big takeaway is just that - you can choose to aim for your goals in whatever way you see fit.

But don’t be too quick to discard anything you think is restrictive.

Putting little speed bumps in your process can force you to justify choices to yourself instead of zooming straight into rash decisions.

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