Why it’s important to avoid being overexposed to one fund house

Growth shares falling out of form in recent months has hurt fund firms, including Baillie Gifford, that focus on this part of the stock market.

Investors in Baillie Gifford’s funds have experienced a roller-coaster ride over the past two years.

The asset manager’s distinctive long-term, growth-focused investment approach runs across its fund and investment trust range, which includes Scottish Mortgage (LSE:SMT). The idea is to spot tomorrow’s winners – companies able to deliver sustainable growth in earnings and cash flow – and to not be influenced by benchmarks or competitors.

It is an approach that paid off over the five years to late 2021, with stellar performance across the range. This was in large part down to Baillie Gifford’s bias towards growth-focused sectors, such as technology and healthcare, which performed well in the deflationary environment that dominated after the global financial crisis. As Baillie Gifford recorded strong returns over the years, investors flocked to their funds, causing assets under management to balloon in size.

However, since the start of the year things have taken a turn for the worse. As it became clear that inflation was anything but transitory and interest rates would continue to rise across parts of the Western world, investors started to reappraise the prospects for growth stocks, previously prized for the promise of their future earnings. As higher interest rates diminish the value of these growth stocks, investors have turned their attentions to value stocks, such as banks and oil majors, instead. 

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Over the past few months, Baillie Gifford’s performance has disappointed and investors have started to reconsider the merits of an out-and-out growth style at this point in time.

“Some fund management groups have a particular style and are therefore likely to run similar strategies across all their funds. This is worth considering if you find yourself invested more in one fund group than others,” explains Dzmitry Lipski, head of funds research at interactive investor.

“After all, it means that when one of their strategies suffers, they all do. That’s why we believe it is a good idea to spread risk across management groups.”

Baillie Gifford’s recent run of disappointing performance may well have been a wake-up call for some investors, who are realising that they have too much invested with one asset manager.

Having a distinctive house investment style can be both a blessing and a curse: it is a blessing when market conditions are supportive of that style and a curse when they are not.

It is also worth noting that Baillie Gifford isn’t the only firm with a house approach. Other examples include Lindsell Train and Evenlode – two companies that focus on ‘quality’ businesses.

Avoid putting all your eggs in one basket

Nathan Sweeney, Marlborough’s deputy chief investment officer of multi-asset, says it is important to hold funds from a range of asset managers to insulate your portfolio when an individual fund disappoints.

“In the investment world, people often say, ‘Don't put all your eggs in one basket’, and it's precisely for this reason. No one fund will work all the time,” he adds.

Peter Sleep, a senior investment manager at Seven Investment Management, says the first priority for any investor is to make sure their portfolio is spread across a range of asset classes and geographies.

“Once you have achieved that, then you should think about whether you are happy with the number of fund managers in your portfolio,” he says.

“Some fund houses like Baillie Gifford have a very pronounced style and as a result their funds can be volatile. When I look at an active fund, I try to understand the fund’s style and then I look for another fund to complement it to reduce the overall volatility of my ISA or SIPP.”

Lipski agrees. As an example, he suggests investors in Fundsmith Equity, which focuses on quality established businesses around the world, could consider complementing this with Artemis SmartGARP Global Equity, which invests in attractively valued companies with growth potential. Both are members of interactive investor’s Super 60 list.

Andrew Wilson, chief investment officer at Lockhart Capital Management, highlights three reasons to make sure your portfolio is diversified across a number of fund management groups.

“First, to avoid concentrated corporate risk, but also to dilute any significant house ‘style bias’, which can have an impact across funds, sectors and even asset classes,” he says. 

Finally, he points out that there can be an element of ‘groupthink’ among certain asset managers, which means unwittingly that there could be some crossover in the stocks that are held or the sectors that are favoured or excluded.

How to identify a house style

So, how can investors work out whether a specific investment style dominates an asset manager’s fund range?

Wilson suggests checking the fund group’s website in the first instance to see if they publicise a house view.

“In addition, there could be crossover in stock holdings or sector positioning across their funds,” he adds.

At the individual fund or investment trust level, annual reports, commentaries, factsheets and blogs should shed light on whether there is a clear style bias. These can all be accessed via the fund group’s website.

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Sleep notes that it can be challenging for investors to gauge whether a firm has an overarching style but when it comes to individual funds, he highlights Morningstar’s website, which features a ‘style box’ for each strategy, which is helpful. For equity funds, this indicates whether the manager favours small, mid or large-caps, and a style that is classified as value, growth or a blend of the two.

He adds that not all asset managers will follow a house style. “Most large fund houses tend to be style agnostic and will try to offer a range of large and small company funds, as well as value and growth funds, so the fund house may not indicate the style or philosophy of the underlying fund manager,” says Sleep.  

Boutiques versus large firms

There’s also the question of whether boutique (smaller) asset managers give their fund managers more freedom in terms of not having to toe a corporate line or a house style.

“In the majority of cases, the answer is an emphatic yes,” says Sweeney. “A boutique’s whole concept is to provide differentiated funds, run by talented people, and to let that talent shine.”

He adds that large firms are typically seen as less entrepreneurial and more bureaucratic. However, there are always exceptions to this rule.

Sleep notes that some boutiques are made up of entrepreneurial fund managers who “band together but do their own separate thing”, citing Artemis and Redwheel (formerly RWC Partners) as examples.

In some cases, each fund management team may keep a large proportion of the profits they generate, but share marketing, IT and administration costs with other teams.

Wilson agrees that fund managers from boutiques tend to be under less pressure to toe a corporate line, but he points out that greater freedom doesn’t necessarily equate to superior returns. For example, larger firms may benefit from having more resources, such as analysts and economists.

“Hence, a house view is both important and helpful,” he adds.

Diversifying across passive managers

While there is a case for making sure you are not overexposed to one fund management group if you have a portfolio of actively managed funds, does the same rule apply for a portfolio of passive funds?

The thinking here is that passive funds and houses tend to have less of a style bias, as they are generally buying the market or an index.

“I think it is a myth that you need to diversify passive managers, but most investors seem to like to do it. Diversifying passive managers probably doesn’t hurt though,” Sleep says.

Sweeney takes a different view. He says there is a strong case for diversifying across passive fund groups, noting that managers can adopt different approaches to the same markets or indices.

“Passive is not a foolproof way of investing. There may be additional risks embedded in products marketed for their simplicity and transparency, such as the use of complex derivatives or stock lending, so it's worthwhile reading the small print.

“For these reasons, I would advocate diversifying your passive investments,” he concludes.