As ISA season heats up, Sheldon MacDonald (pictured), CIO of Marlborough, shares his latest blog with us. Always a good read, this time, Sheldon argues that picking funds is a bit like dealing with baboons – that it pays to be flexible and the best results come from blending gut instinct with cold, hard data.
The Evolution of Fund Selection
I hesitate to describe myself as an industry veteran, as to do so might encourage the notion that I’m nothing more than a wizened Luddite with a fiercely anti-tech outlook. But it’s right to concede many of the techniques used to pick funds today weren’t available for a large part of my career.
As a result, I was firmly in the “direct engagement” camp for many years. I pounded the gravel, pressed the flesh, wined and dined and all the rest. I made it my business to meet with fund managers and try to understand their thinking, their mindsets and even their personalities.
The members of a new breed – or, if you prefer, a new generation – have learnt to do things very differently. Broadly speaking, they hold that data science reveals all and there’s no need to dig deeper.
I ought to stress at this stage that you should stop reading now if you’re hoping for an ironclad declaration as to which approach is superior. I don’t believe it’s especially productive to choose an undisputed “winner” here.
Weighing Up the Pros and Cons
It’s instead more useful to consider each school of thought’s strengths and weaknesses. This should tell us how the two might complement each other and why, on balance, both can have a role to play. As you may be intrigued to discover, it’s also helpful to talk about baboons.
The Case for Direct Engagement
The major criticism of direct engagement is that it reveals little or nothing that couldn’t be deduced from performance figures and the like. To be blunt, this is a claim I just don’t buy.
Investing always represents something of a leap of faith, for the simple reason that none of us knows what might happen tomorrow. Crucially, direct engagement can provide a valuable sense of what a fund manager might do if and when something out of the ordinary does occur.
There’s always a risk, of course, of being “sold” on the strength of a manager’s charisma. However, this is likely to happen only if the level of engagement is superficial. Regular meetings and continued dialogue should guard against such a misstep.
The Power of Quantitative Analysis
None of this is to imply quantitative analysis is any way shallow. Quite the contrary: it can shed an enormous amount of light. Yet I see it as a great starting point rather than as the be-all and end-all.
Imagine, for instance, that a superabundance of data shows a fund has performed outstandingly over a period of 10 years but disastrously over a period of 12 months. What does this actually tell us? Wouldn’t an explanation from the person responsible be pretty handy?
While the above is an oversimplistic example, the argument is plain enough. Quants may reckon they have all the answers on their screens, but it might be more accurate to say they have an awful lot of questions – truly instructive responses to which can be gleaned through meaningful, candid interaction between human beings.
A Lesson from the Baboons
It’s at this point that we need to drop a few notches down the evolutionary scale and discuss baboons. Many communities in my native South Africa suffer incursions by marauding gangs of these primates, with some residents favouring a policy of adaptation and co-existence and others believing the most straightforward solution is to shoot them.
The village where my brother lives reached a noble compromise: shoot them – but only with paintballs. Anyone who has ever been hit by one of these projectiles will appreciate why this strategy quickly proved a success.
But baboons aren’t stupid. It took them barely two weeks to accurately determine the range of the average paintball gun. They now maintain a safe distance before carrying out lightning-fast raids on homes, cars, shopping trolleys and so on.
Striking a Balance
The moral of the story? Things tend to work until they don’t. What looks like a wonderful idea today might not be so brilliant next week, next month, next year or somewhere further down the line – which is why it usually makes sense to be flexible and not rely on a single approach.
As investors, we’re fortunate to exist in an era in which a wealth of data can do the heavy lifting – not least through ever-increasing use of artificial intelligence – and humans can still apply the qualitative layers of nuance and insight required for genuinely informed decisions. This combination should enable more coverage, greater efficiency and, ideally, better outcomes.
In my view, the future of fund selection therefore clearly lies in a “best of both worlds” approach – one that blends the conventional with the cutting edge to maximum effect. We don’t need to replace tried and tested methods – but there’s plenty to be said for constantly adding to them.
Sheldon MacDonald is CIO of Marlborough.
