A small band of unit trust providers consistently outstrips the markets. But attempts to improve the industry could mean fewer star performers

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The Independent Online
I am indebted to John Cuthbert, an academic and investment researcher, for some further thoughts on unit trusts, about which I wrote last week.

He has recently completed the third in a series of annual analyses of how the various unit trust management groups have performed in the previous three years. His findings raise interesting points about the way the industry is changing, the way it manages funds these days and also about what it takes to produce consistent above average performance, the Holy Grail that everyone in the business - saver and provider alike - is looking for.

Two things primarily distinguish Mr Cuthbert's analysis from most surveys of fund manager performance. One is that he is mainly interested in the overall performance of each management group's funds, rather than in which individual fund has done best over any given time frame.

Second, he uses some advanced statistical tools to try to distinguish what lies behind the success of those groups which achieve the best results. The questions he is interested in are: firstly, how much of any outperformance is due to skill, as opposed to luck? and secondly, how important is the way that the fund management group organises itself in securing good or bad performance?

The two key measures he uses to assess performance records are the consistency with which funds under or outperform their relevant market index over a three-year period; and the extent to which their performance deviates from the norm. The second measure he calls tracking error, and it gives an indication of how actively each fund manger is trying to beat the market.

(If you thought they all were, think again. Although there are only a handful of explicit index-tracking funds in the UK there are also a large number of what are known as closet indexers. These funds' managers in practice stick fairly closely to mimicking the market averages. They are hoping to beat it by a small margin, but don't want to risk underperforming it by a large margin, which could put their careers in jeopardy.)

Mr Cuthbert's first finding should come as no surprise, since it merely confirms what has been shown many times before. This is that the majority of managers of UK equity unit trusts add no value at all, in the sense that they consistently failed to outperform the FT All Share Index across the range of their funds in the years 1994 to 1996. In fact, 58 of the 91 main fund management groups subtracted value in this sense.

However, his second finding is that there is a small and elite group of investment management groups which have consistently added value. There are 11 firms which have outperformed the market with at least two thirds of their funds in all three of Mr Cuthbert'sannual surveys. Twenty did so in the 1994-96 period alone.

Who are these paragons? Well, stripping out a couple which have been affected by takeover or other corporate changes, and ignoring firms that only sell to institutions, the list includes the following: Britannia, Jupiter, Lazards, Perpetual, Schroders, ABN Pembroke, BWD, Credit Suisse, Prolific and NPI.

It is an interesting list, for it not only includes some of the best- known names in the retail market but also some which I hazard most people have never even heard of. (Pembroke Carrington, for example, recently bought by the Dutch bank, ABN Amro, is a small firm with an excellent long-term record but, though popular with aficionados, is largely unknown to the general public.)

In addition, there are some big names missing from the list too, such as Fidelity and M&G, both of which have had well-publicised recent difficulties. Mr Cuthbert acknowledges that his methodology tends to penalise firms such as M&G which specialise in buying high yielding stocks rather than growth shares.

Nevertheless, nobody doubts there are a handful of firms which are simply better than others. One thing many of the best firms have in common is a distinctive investment style which they have stuck to over a long period of time. Quite often, also, the same fund managers (eg Bill Mott of Credit Suisse, Neil Woodford at Perpetual, John Carrington and Nigel Thomas at ABN Pembroke) have stayed with their funds over a period of several years.

A secondary point that Mr Cuthbert does make strongly - and which my own observations also support - is that historic performance figures may be particularly misleading at the moment. This is not just for the well- known reason that beating the averages is hard, and that those funds which perform well in one year tend to do less well in subsequent years. It is also because behind the scenes there is - and not before time - something of a revolution going on in the way that many unit trust groups are organising their investment activities.

To put it bluntly, too many unit trust groups have been poorly run over the years: investment trusts have always tended to have the better quality fund managers. But this is at last starting to change. Don't be surprised to find a number of groups which have historically tended to do badly now start to produce rather more consistent performances in future, thanks to much improved/more professional investment processes.

Mr Cuthbert says he already detects big and probably lasting improvements in places such as Hill Samuel (now part of Lloyds TSB), Invesco, Kleinwort Benson, Save & Prosper and Eagle Star/Allied Dunbar (whose funds are to be relaunched under the Threadneedle Asset Management label).

But nor should you expect to discover many more stellar performers. The process of organising unit trust groups more efficiently will if anything, Mr Cuthbert predicts, reduce the number of fund managers who take - or are allowed to take - really big bets in the market. We can look forward to generally higher standards, in other words, but fewer places where risk-taking fund managers of the kind who have taken Jupiter and Perpetual to the top of the tables in recent years are given their heads.

Unit Trust Management Performance Studies, available from John Cuthbert, 36 Stothart Road, Sheffield S10 1RE.

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