The butterfly effect: understanding star manager risk

2 Sep 2015

What should investors do when the star manager running their money ups and leaves? Emma Cusworth considers the options.

“Is a firm run as a star manager culture? If yes, it’s important clients really understand what they will do if that manager leaves. Did that manager really own the process? If yes, get out and you don’t want to be a late leaver.”

Deb Clarke

It was the famous pioneer of chaos theory, Edward Lorenz, who first coined the phrase ‘the butterfly effect’. His initial example of this notion explored how a butterfly flapping its wings could influence a hurricane several weeks later, but the analogy translates well into the investment world.

Consider, for example, the compound impact on numerous investment portfolios and the wider investment industry stemming from ‘butterfly’ managers moving jobs. Former Pimco CIO Bill Gross is perhaps the most notable example, whose acrimonious departure in 2014 caused a landslide of assets, the financial and resource costs of which will be very widely felt.

Butterfly (or ‘star’) managers have long been known to present a specific set of risks for investors, but as the investing community moves increasingly in favour of high-conviction alpha strategies, the importance of analysing the extent to which a manager has a butterfly effect should not be underestimated.

IDENTIFYING BUTTERFLIES

Identifying butterfly managers is sometimes pretty straightforward. The investment world is littered with examples of managers who, no matter how press-shy, have significant influence on the markets they invest in – Warren Buffett, The Sage of Omaha, and the aforementioned Gross, spring immediately to many minds in this regard. But the ripple effects of manager changes can be felt much more broadly than the most obvious names (although the bigger the butterfly, the bigger the effect seems to be).

According to Nathan Gelber, CIO of investment consulting firm Stamford Associates, butterfly managers “typically tend to be individuals with a genuine investment approach and an entrepreneurial mindset, and typically deliver concentrated, highconviction portfolios with a preponderance of idiosyncratic risk – almost like holding a conglomerate of 20 holdings”. They also tend to have a very clear long-term outlook and a pronounced alignment of interests with investors as they invest material sums in their own funds.

These managers largely tend to be found in boutique organisations, often of their own creation, and the last 20 years has seen a shift of these types of managers towards the hedge fund rather than traditional longonly space. Their presence is by no means exclusive to the hedge fund world, however, and two of the most prominent examples of recent years – Gross and former Invesco Perpetual manager Neil Woodford – are clear exceptions to the rule.

GROSS FLUTTERS HIS WINGS

When Gross, who co-founded Pimco in 1971, announced on 26 September last year he would be leaving to join Janus, the investment community responded in force. Gross’s Total Return fund immediately began to haemorrhage assets. The fund closed 2014 with AUM of $143.4bn, $105bn short of where it had started the year and less than half that of the fund’s peak of $293bn in April 2013. By the time of writing the fund had lost another $40bn, down to $103bn, despite a trio of senior Pimco portfolio managers taking over the helm, including Scott Mather, CIO US Core Strategies, Mark Kiesel CIO Global Credit, and Mihir Worah CIO Real Return and Asset Allocation.

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