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Do investor surveys really help?

08/09/2016

Most active fund managers underperform, meaning their clients would have done better investing in an index fund. So it seems strange to ask them how to run your company. Analyses of active versus passive fund management performance are sobering. There are many other reasons to be suspicious of investor surveys. Investors are a heterogeneous and fragmented bunch whose advice will almost certainly be contradictory. Most investors are paid on a 12 month performance basis leading to an emphasis on short-term fix advice. This likely explains their poor performance, but also is the wrong timescale on which to manage business strategy. We rarely see surveys that surprise IR managers. Oakhall isn’t an IR consultancy in the traditional sense, but where we work on IR projects we roll up our sleeves to really understand your business and then help you proactively take control of investor relationships, rather than react to them.

The investing profession remains opaque to most people, including many company executives. This, together with the huge pools of other peoples’ money that they manage,  tends to lead some executives to treat investors with deference. That deference may not be deserved.

Morningstar’s Active/Passive Barometer looks at US fund manager performance by sector over the last 10 years. The results are displayed graphically above.  The median success rate of fund mangers over the different fund groups analysed is 27%, meaning that 73% of them fail to outperform passive index funds with no active stock selection.

The worst sectors are “US mid blend” (which means US funds investing in mid-cap companies across value and growth strategies), and “US large growth” where the active investor success rate is just 12% and 14% respectively over 10 years. Investors over 10 years in the sectors would on average lose 19% and 10% respectively of their savings over 10 years compared to investing in passive funds.  “Only US mid value” has more successful than unsuccessful active fund managers. Morningstar didn’t yet survey UK or European fund managers but with a similar fragmented industry structure we’d expect similar results.

This isn’t an indictment of all active managers. But there is a long tail of poorly performing funds. Even without the poor performance, there are other reasons to doubt the average fund manager’s ability to offer strategic advice. Industry fragmentation, in terms of investment process, is one reason. The Morningstar data differentiates between value, growth and blend (a mix of the two), and between investors in large, mid, or small cap shares. But there are many more gradations – GARP (growth at reasonable price), income, short term earnings momentum, M&A arbitrage, long-short, each with their own set of preferred characteristics that they look for in a stock. Plus the performance period over which they are measured is typically 12 months, and it can be as little as three months.

This means that investor advice tends to be generic (“give more disclosure”), contradictory (“invest more in the business”, “return more capital to shareholders”, “raise leverage”) or short-term (“do a share buy-back”). Short term advice is particularly damaging as we see executives wasting time considering it, not realising that the investor offering the advice will be long gone once the supposedly short-term share price positive action is taken.

Finally, there are your largest shareholders to consider. We generally find that investors who own more than 5% of a company are keen to offer advice to executives, and executives are eager to receive it. Whilst it is tempting to assume that someone who has invested so much in your business must be some kind of genius, it is important to remember that they are just one drop in the ocean of investor opinion and they do not necessarily represent the views of investors who have chosen not to buy your shares. In fact given that they are “in”, you might do better to look for other opinions, from investors you trust but who don’t yet own your shares. So, take the advice on board but not necessarily as definitive. There are other fish in the sea.

Oakhall isn’t saying that surveys should be completely avoided – surveys conducted after, say, a capital markets day, can be useful to gauge what did and didn’t work in the presentations, or what was missing. But generic surveys could be just telling you what you should already know.

Related Links:
Morningstar Active/Passive Barometer – a fascinating read, Morningstar’s conclusions not only cast doubt on the ability of most individual fund managers, it also notes the high mortality rates of funds, and the evidence that lower fee fund performance is materially superior to higher fee funds. According to their analysis, fee rates are the only reliable indicator of fund manager success.

Oakhall was established by top-rated equity research analysts to help CEOs and CFOs better analyse their own business and strategies, and articulate them to stakeholders. Founder Andrew Griffin spent almost two decades as a technology equity analyst, ultimately as managing director of European technology equity research at Bank of America Merrill Lynch, before working in investor relations, corporate development and market intelligence for a UK listed software company.