Benchmarks are not just restrictive to investing, but actually damage returns, according to head of European Equities at F&C Asset Management David Moss.
Moss, who runs the F&C European Equity fund said that his unconstrained fund allowed him to focus on the merits of individual companies, rather than box ticking sector allocations.
“There are equity sectors that are not represented in the portfolio not because we have a negative view on the sector, but because I have higher conviction in a company that sits outside it. As a team we look to buy and hold companies for a long time – and the stock’s fundamentals drive that decision, not any benchmark,” he said.
Both Moss and his colleague Mark Nicholls who runs the F&C European Growth & Income fund have very low portfolio turnover as a result.
Colm McDonagh, Head Emerging Market Fixed Income at Insight Investment, points out that emerging market debt indices weighted by market capitalisation can be inefficient and a poor investment – only considering the size of a nation ignores other pertinent issues such as contagion risk, currency strength and competition.
“The investment industry’s obsession with tracking a benchmark creates dangerous investment biases,” he said. “If you have a long only portfolio even an underweight position in an unstable market can be too large - 2% underweight a 10% index is still 8% exposed to danger.”
Benchmark hugging is particularly dangerous when your investable universe is heavily overweight one extremely cyclical sector. Emerging Europe investor David Reid, who runs the BlackRock Emerging Europe trust (BEEP) says as Russia makes up a sizable proportion of his region the benchmark contains lots of oil and gas stocks, but in the current market he prefers other opportunities.
“The trust is focused and unconstrained – I invest in between 20 and 30 companies – which allows us to break away from the MSCI Emerging Europe benchmark,” he said.
“The benchmark is size and sector biased, three quarters of it is energy stocks and many of those are state owned enterprises. We have 30% of the portfolio in energy. Technology stocks, which we like, do not feature in the benchmark at all.”
Refusing to benchmark hug can also be the mark of a good active fund manager. After all if you want to invest solely in a market cap weighted indices it would be considerably cheaper to simply buy an exchange traded fund.
If you are paying up to 1.5% a year in management fees, it is fair to expect that the asset manager is considering the whole of the available universe and cherry picking the best stocks for their investors.
