Home / Peter Elston’s Investment Letter – Issue 27: August 2017

Peter Elston’s Investment Letter – Issue 27: August 2017

Stop press: Awards announcement

We have been shortlisted for two awards – Multi-Asset Manager of the Year and Investment Boutique of the Year. I am very proud of my team. In a world of rising ‘passive’, it is incumbent on us to continue to offer our customers highly differentiated products. This is what they pay for and this is what they will get.

An attack on poor active management

I abhor poor active management.

I abhor it because there are so many individuals whose retirement savings have been invested in poor products; because it has given the active management industry in general a bad name; and because the big firms who are the worst offenders (1) continue to peddle the notion that bigger is better – witness a certain recent merger – when in fact my – and Warren Buffett’s! (2) – opinion is that the opposite is the case.

Small & interesting PE IL 27 - August 2017

With, for example, football clubs and DRAM companies, bigger generally means better quality. This absolutely should not be the case with active management, where the more interesting investments tend to be smaller and thus out of the reach of large firms.

While I abhor poor active management, I adore Gina Miller (on a strictly professional basis I should add). I too get an itch when I think “people are being bullies, or being dishonest or hypocritical”(3). Most big fund management companies for me tick all three of those boxes.

I do not think I am alone in thinking this way. Indeed, although I am very critical of my industry, there are many outside it whose criticism of active management is far more vitriolic. Some will have had a bad experience investing in an active fund, others will have been appalled at the asymmetrical rewards on offer in the industry, others still may see us as a bunch of coin tossers masquerading as skilful practitioners.

Whatever the reason, there is plenty of evidence that most actively managed funds fail to beat their benchmark net of costs (4) – this is indeed the way the newspaper headlines always seem to be framed. However, the implication of this – and the headlines – is that funds that beat their benchmark have done a good job, and that funds whose performance is in line with the benchmark have achieved what they set out to achieve.

This has to be wrong.

Active managers should be aiming to beat their benchmark by a wide margin to compensate investors for the risk that they will fail to reach it. Why on earth would I as an investor accept index performance with risk when I could get, from a passive fund, index performance with no risk?

Most single asset class funds have an investment aim or objective that is vague, and a benchmark which is an index (this was certainly the case with ten UK equity funds that I selected at random). Where there is a benchmark stated, it is not generally clear what it is there for, but let’s assume it is for investment performance measurement purposes – after all the proper definition of a benchmark is ‘a measuring device’ rather than ‘something to be copied’, not that you’d know it by looking at many funds’ holdings.

So, I have a simple solution. Active funds should state the margin by which they aim to beat their benchmark, net of costs. For example, FTSE All Gilts + 2% per annum, or S&P500 + 3% per annum. At Seneca, we do this with our multi-asset funds, either explicitly or less formally, taking account of the value we seek to add from active management decisions.

Furthermore, why would performance in line with benchmark be acceptable when what this means is that managers give all the outperformance to themselves in fees once other costs have been paid, leaving nothing for the customer!

So, I have a different approach.

My starting point is to consider the costs for a particular fund, then to aim to produce a multiple of these costs in gross outperformance (alpha). I make sure that we have sufficient tracking error to give our funds the potential to produce this alpha (too little tracking error is in my view worse than too much) then trust our value-oriented investment style and process to achieve it.

What is the multiple? It depends on the total costs, but for all three of our funds, it’s considerably above two.

We recently changed the benchmark for our investment trust, the Seneca Global Income & Growth Trust, to:

“Over a typical investment cycle, the Company will seek to achieve a total return of at least CPI plus 6 per cent per annum after costs with low volatility, and with the aim of growing aggregate annual dividends at least in line with inflation, through the application of a Multi-Asset Investment Policy.”

Benchmark changes are generally met with great scepticism, and rightly so, but in our case we have raised the bar rather than lowered it. Furthermore, the change will not mean we have to start jumping higher (we will not change the way we manage the fund). The bar has been raised to a level commensurate with our process rather than at an inappropriately low height.

It had become increasingly clear to us and to the Trust’s Board in recent years that the previous benchmark of LIBOR + 3% did not reflect how the trust was being managed. Nevertheless, there were some who expressed concern that the new benchmark was too ambitious.

Given my earlier remarks, I would argue instead that the objectives of most actively managed funds are not ambitious enough. Perhaps this is why the active management industry is so despised. Many, including me, think it is still providing a safe harbour for the cowardly.

Interesting anomaly with respect to global fund managers’ AUM rankings

I mentioned at the start of this letter that we had been shortlisted for two prestigious awards. We were nominated in two of 18 categories, which I thought was very impressive for a firm of our size. As I thought about size, I wondered where we ranked in the world, and came across a list of the top 400 fund managers by AUM(5) compiled by Investment & Pensions Europe. We were not on it – the 400th largest was 20 times bigger than us – so I wondered if I could extrapolate the numbers to estimate where we stood.

What revealed itself was fascinating.

I plotted AUM against firm size rank and added a power law trend line (Chart 1). The trend line didn’t fit very well, so I tried an exponential trend line. That didn’t work very well either (Chart 2) but I wondered if the biggest companies followed a power law and the next biggest followed an exponential pattern. The results were extraordinary (Chart 3). The top 65 companies clearly follow a power law, and the next 365 an exponential pattern.

I would welcome suggestions from readers as to why this might be the case. And I’d be keen to collaborate on a research paper if there are academics out there with time on their hands!

For further reading on the subject of power laws in relation to size ranking, whether fund managers or cities, see Power Laws in Economics – An Introduction (6).

Incidentally, the equation for the exponential trend line in Chart 3 that relates to the lower ranked companies can be reworked as:

Firm rank = 556 – 91.5 times the natural logarithm of AUM

At the end of December 2016, we had AUM of £300 million, which translates to US$370 million. Plugging this into the above equation reveals that (drum roll) we are the world’s 647th largest fund manager.

Blackrock had better watch out. We’re a-comin’ to getcha!

Chart 1: Applying a power law trend line to all 400 companies

PE IL 27 - Chart 1

Chart 2: Applying an exponential trend line to all 400 companies

PE IL 27 - Chart 2

Chart 3: Applying a power law trend line to top 65 and an exponential trend line to next 365 (including trend line equations)

PE IL 27 - Chart 3

Wealth creation from US equities since 1926

I was alerted by an article in the Evening Standard to an interesting research paper entitled Do Stocks Outperform Treasury Bills?

The author used data from the Centre for Research in Securities Prices (CRSP) to analyse performance of all listed companies in the US going back to 1926. He found that just 30 stocks (Table 1) accounted for one third of total listed equity wealth creation, 90 for half, and 1,092 (out of a total of 25,300) for all (meaning that collectively 24,208 created zero wealth). Let that sink in.

If you are wondering how 24,208 firms can create zero wealth, take a look at Chart 4. It looks like around half of the 24,208 firms created wealth, but the wealth they created in aggregate was cancelled out by the other half that destroyed wealth.

Interestingly, the top 30 company that created wealth at the fastest rate was Facebook. It created $181,243 million in 56 months, which equates to $1,232 per second. This was almost double second placed Alphabet’s speed of $678 per second. I wonder if this says something about the relative value we place on communicating with friends on the one hand and looking for stuff on the other. Another research paper perhaps?

Table 1: Lifetime Wealth Creation

From Do Stocks Outperform Treasury Bills? (7) By Hendrik Bessembinder, Department of Finance, W.P. Carey School of Business, Arizona State University.

“This table reports lifetime wealth creation to shareholders in aggregate. Wealth creation is measured by text equation (2) [see page 23 of the paper if you are feeling brave! – Ed] and refers to accumulated December 2016 value in excess of the outcome that would have been obtained if the invested capital had earned one-month Treasury bill returns. Results are reported for the 30 firms with the greatest wealth creation among all companies with common stock in the CRSP database since July 1926. The name displayed is that associated with the Permco for the most recent CRSP record.”

PE IL 27 - Table 1

Chart 4: Cumulative % of wealth creation, all companies

PE IL 27 - Chart 4


(1) http://betterfinance.eu/media/latest-news/news-details/article/better-finance-replicates-and-discloses-esma-findings-on-closet-indexing/

(2) https://www.fool.com/investing/options/2013/06/03/is-this-buffetts-secret-to-50-returns.aspx

(3) https://www.psychologies.co.uk/gina-miller-philanthropy-and-transparency-politics

(4) Source: S&P Dow Jones data from 25,000 funds over ten years to end 2015

(5) https://www.ipe.com/download?ac=71409

(6) http://pages.stern.nyu.edu/~xgabaix/papers/pl-jep.pdf

(7) https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2900447

Current fund targets

The target weights in the table below are where funds should be positioned currently. Actual positions may deviate slightly from these target weights as a result of market movements or ongoing trades for example.

Table 2: Current fund tactical asset allocation (TAA) target weights as of 31st July 2017 (prior month’s targets in brackets)

PE IL 27 - Table 2


  • The US dollar continued its decline that began in December, most notably against the Euro
  • Inflation in the US has been weak of late, prompting many to wonder about monetary policy
  • As expected, the Fed left interest rates unchanged, but indicated that it would start to shrink its balance sheet soon
  • Equity markets and commodities were generally firm, reflecting improved global growth
  • Excellent results from Conviviality, with strong cash generation evident. The benefits of ‘One Conviviality’ i.e. providing a “onestop
    solution” are starting to emerge
  • We are moving towards an exit of Blue Capital Alternative Income where we feel the trust is too small to support its long term future


  • Good trading updates from Clinigen, RPC and Victrex
  • Following strong performance, overweight positions in Invesco Perpetual European Equity Income Fund and Somerset Emerging Markets Dividend Growth Fund were trimmed
  • There were no fixed income transactions during the month


  • Good trading updates from Dairy Crest, RPC and Victrex
  • Following very strong performance during the month, BlackRock World Mining Trust was reduced back towards target weight. The Trust remains at an attractive discount to net asset value
  • Fixed income positions were reduced over the month to build cash balances
  • The recent cooling off by the US Dollar enabled us to modestly increase the holding of DP Aircraft, the listed aircraft leasing vehicle


  • Good trading updates from Dairy Crest, RPC and Victrex
  • There were no transactions in overseas equities during the month
  • There were no fixed income transactions during the month
  • The recent cooling off by the US Dollar enabled us to modestly increase the holding of DP Aircraft, the listed aircraft leasing vehicle

Download this investment letter as a PDF


Important Information

Past performance is not a guide to future returns. The value of investments and any income may fluctuate and investors may not get back the full amount invested. This document is provided for the purpose of information only and if you are unsure of the suitability of these investments you should take independent advice.

The views expressed are those of Peter Elston at the time of writing and are subject to change without notice. They are not necessarily the views of Seneca and do not constitute investment advice. Whilst Seneca has used all reasonable efforts to ensure the accuracy of the information contained in this communication, we cannot guarantee the reliability, completeness or accuracy of the content.

LF Seneca Funds
These funds may experience high volatility due to the composition of the portfolio or the portfolio management techniques used. Before investing you must read the key investor information document (KIID) as it contains important information regarding the funds, including charges, tax and fund specific risk warnings and will form the basis of any investment. The prospectus, KIID and application forms are available from Link Fund Solutions, the Authorised Corporate Director of the funds (0345 608 1497).

Seneca Global Income & Growth Trust plc
Before investing you should read the latest Annual Report for details of the principle risks and information on the trust fees and expenses. Net Asset Value (NAV) performance may not be linked to share price performance, and shareholders could realise returns that are lower or higher in performance. The annual investment management charge and other charges are deducted from income and capital.

Seneca Investment Managers Limited is the Investment Manager of the Funds (0151 906 2450) and is authorised and regulated by the Financial Conduct Authority and is registered in England No. 4325961 with its registered office at Tenth Floor, Horton House, Exchange Flags, Liverpool, L2 3YL. FP17/342