Active managers must stick to stockpicking and drown out the macroeconomic & political noise when investing, according to Standard Life Investments fund manager Thomas Moore. 
Last year, many active UK equities managers underperformed the FTSE All Share as the return of the value trade and uncertainty over the decision to leave the EU panicked markets.
Indeed, both the IA UK All Companies and IA UK Equity Income sectors underperformed the benchmark index by 5.92 and 7.9 percentage points respectively.
Performance of indices in 2016
Source: FE Analytics
In fact, only 15 per cent of UK equities funds from both sectors beat the index in 2016.
Thomas Moore was one fund manager that struggled last year, but he said active managers should add value over the longer term.
“We need to work out where we can add value as active fund managers,” the manager of the £1.1bn Standard Life Investments UK Equity Income Unconstrained fund said.
“Our most likely way to add value as active fund managers is by identifying some stock-specific insights.”
He said by meeting companies, fund managers can get a “pretty good cross section of the UK economy” and their competitive advantage derives from taking a view on “where we believe there are some truths and perhaps where we believe people are telling us porky pies”.
One example of this is Provident Financial, a popular stock among UK income funds that recently issued a huge £60m profit warning this month.
This this was a well-liked stock that the market consensus thought would be a strong performer over the long term, but Moore disagreed.
“I scrupulously avoided this stock. This stock was priced at 5.5 times its book value. A lender like Lloyds is on roughly one times book value. Even another specialist lender like Close Brothers is on two times book value,” he said.
He added that the company was “priced for perfection” with a price-to-earnings (P/E) multiple of 16 times.
Yet, Moore sees this example as positive for fund managers. He said: “I think it gives us encouragement because it means that anybody who’s actually focused on where the risks lie [should avoid stocks like these].”
Instead, he bought its peer Close Brothers, which has not experienced the same rise as Provident Financial, but has avoided some of the same issues.
“Sometimes you need to be on the other side of consensus and saying actually there are companies that are going to get through this cycle that aren’t desperately over-loved now but in two or three years’ time when things are improving for these companies they will be seen as compounders,” Moore said.
“I would say that it is incumbent on us fund managers as stewards of capital to sort out the wheat from the chaff and decide are we going to go with the herd or are we going to find some hidden gems that are on much lower valuations with just the same kind of long-term prospects but without the profit warning potential.”
However, while fund managers can add value through stock selection, when the macroeconomic environment changes, active fund managers may struggle.
“Where I’m going to admit we come short sometimes is that macro events happen and they can derail our performance in the short term,” he said.
“We have had four macro events in the past four years. David Cameron won a clear majority in 2015 and from a market perspective – that went reasonably well.
“That was perceived to be a market friendly event and the year before we had the Scottish referendum – so we had two relatively market friendly events.
“Then in 2016 we had the Brexit referendum and some of us weren’t particularly well prepared for that.”
Indeed, Moore’s Standard Life Investments UK Equity Income Unconstrained fund was the worst performer in the IA UK Equity Income last year, losing 4.10 per cent.
Performance of fund vs sector and FTSE All Share in 2016
Source: FE Analytics
“Our best years are when people aren’t worrying about the macro but when people are looking at the stocks you’re buying and saying there are good stories from the point of view of top-line growth, cashflow coming through, revenues exceeding costs and operational gearing,” Moore said.
“And that’s what we as fund managers love to see because we can get some intelligence on that early on and take some views on those companies and gain some decent returns.”
However, he said that despite this approach, it will not stop active managers having the odd year where they underperform due to unforeseen macro events.
“We are no better informed on those political events than any of your readers because actually the bookies show that things can go very differently to what the consensus view is pricing in,” the manager said.
The most recent macro event to take place was the UK general election this month, which Moore likened to Donald Trump’s surprise election result in the US last November.
He said investors were more interested in how he was positioning his portfolio heading into these events than usual, as there was a heightened sense of anxiety in the market.
Moore noted: “People are worried and everybody is highly sensitised to these political events at the moment.
“The reality of course is that I am taking views on stocks based on insights that are going to last three, four or five years because they are company-specific insights that are going to be driven by industry trends.
“And whether Theresa May is in power as a clear majority of 60 or she has a minority government, actually in reality that doesn’t make a huge amount of difference.
“We need to stick to our knitting which is working out through all this company insight what’s happening at the industry and company levels.”
He added: “Those can take time to come through – they are not going to come through every week or month and so we are going to have the odd disappointing period where we let people down and we feel pretty bad about that.”
The fund manager pointed to his own track record as an example of funds that take time to develop these ideas but outperform over the long term.
Indeed, despite last year’s underperformance, the fund has outperformed the FTSE All Share in six of the last eight years and is beating the index so far this year also.
Performance of fund vs FTSE All Share over 8yrs
Source: FE Analytics
“I think we are going into a period of micro analysis rather than the macro and one of the reasons I say that is despite minority government and lots of political uncertainty, actually the last three weeks have been perfectly okay from a stockpicker’s perspective,” Moore said.
“The environment is still conducive for those people willing to put their money to work in high conviction stock ideas.”
The fund has a clean ongoing charges figure (OCF) of 1.15 per cent and a yield of 3.78 per cent.