Secrets of Success: Putting his reputation where his mouth is
Saturday 15 May 2004
Over the years I have chucked some brickbats in the direction of the fund management community, so it is a pleasure from time to time to give credit where credit is due.
Over the years I have chucked some brickbats in the direction of the fund management community, so it is a pleasure from time to time to give credit where credit is due. Three years ago Philip Wolstencroft left his job as Merrill Lynch's market strategist in London to try his hand on the other side of the fence as a fund manager with the Edinburgh-based boutique, Artemis.
The move gave him the chance to take the quantitative stockpicking model he had helped to develop while at Smith New Court (which was subsequently sold to Merrill Lynch) and see if it could work as well "in real life". The model is based on a series of quantitative indicators, but focuses on two key variables: changes in earnings estimates and movements in professional investor sentiment.
By tracking revisions to earnings estimates from some 200 broking firms and plotting changes in institutional ownership of the main stocks and sectors in the leadingindices, the model produces a ranking of the stocks and sectors within a given market index. The best ideas from this screening in the old days went to make up Mr Wolstencroft's monthly recommendations as a broker and now form the basis of his new fund, Artemis European Growth.
There is nothing particularly unusual about the approach Mr Wolstencroft adopts - academic studies have long established that changes in earnings estimates have some predictive power and investor sentiment is another obvious market factor that is regularly monitored by broking firms.
But the big question when Mr Wolstencroft decided to move over to the "buy side" of the investment business was: would his model stand up to a practical test? When I talked to him at the time of his move, he told me that the model had outperformed the market by an average of 7 per cent a year when back-tested over several years.
At the time I doubted whether reality would prove quite so welcoming. Yet now, three years on, the first results are in - and very positive they are too. Over the three years to March 2004, the fund has outperformed both its benchmark (FTSE's Europe ex-UK index) and its peer group in all three years. Not only that, but the margin of outperformance has not been 7 per cent per annum, but 15 per cent per annum. What's more, this has been achieved with lower than average volatility.
Of course it is important not to get too carried by bald performance figures. Three years of outperformance cannot disguise the fact that investors have not yet made a huge amount of money from the fund. In its first two years, which coincided with the depths of the bear market, the fund lost money and even after three years the absolute return was just 28 per cent. All the absolute gains have come in the market rally that started in March 2003, and the fund fell back again as the market weakened in recent weeks.
In other words, even a highly successful market analyst - and Mr Wolstencroft was regularly voted the best market strategist by fund managers - cannot buck the most powerful directional trends in the market. Nevertheless, the record of his fund has been impressive and will no doubt continue to hoover up funds from both private and professional investors who want exposure to the currently not very highly rated European equity markets. (It helps that the fund has positions in a number of companies from fringe economies in Europe such as Hungary and Greece, where growth and valuations still look attractive). Although the fund has already grown in size from £20m to £240m, it is not yet so big that its competitive advantage will be eroded by liquidity problems, as so often happens with funds that put together an impressive early record.
Apart from saluting Mr Wolstencroft's decision to back his judgment by starting the fund, it is interesting to speculate why the fund has done as well as it has. The fact that it is largely quantitatively driven is clearly one important factor. According to Mr Wolstencroft, about 80 per cent of the fund's outperformance can be attributed to his model and only 20 per cent to the judgmental adjustments that he and his colleague, Peter Saacke, make to the stock selections.
Although the two men boast five economics degrees between them, they cheerfully admit that they try to behave "like idiots" most of the time, to avoid letting their human emotions get in the way of the objective results of their methodology. Not surprisingly, the time when the model performs worst is at major inflection points in the market, such as March 2000 and March 2003. It is on these occasions that Mr Wolstencroft's many years of experience at tracking the performance of the markets and the behaviour of the professional institutions that dominate the market come most in handy.
The other reason why the fund has done so well, I suspect, is that Mr Wolstencroft's model is beautifully attuned to the dynamics of today's investment markets. At a time when the average professionally managed fund turns over its portfolio once a year in a desperate search for small degrees of relative performance, this model clearly captures the key elements in this zero-sum game far more effectively than most.
The flip side of this is that anyone who enters the field is only as good as their last result. It will be interesting to see how Mr Wolstencroft's fund kicks on from its impressive start. Approval from this quarter is probably the kiss of death for any fund manager, but so far I have to concede that he has done all that anyone can ask.
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