I’ve got my canaries, have you?

After more than a decade of easy markets, signs of complacency are starting to show. At EQ we know that risk can take many forms and often bites when you least expect it. The good news is there are ways to deal with this, but you have to put the effort in.

by Kasim Zafar, 18th October 2019

The recent scandal around celebrity fund manager Neil Woodford shows just how badly things can go wrong when questionable governance standards are met with lower levels of investor scrutiny. It all starts (and ends) with research. Everyone does it, but it simply doesn’t mean the same thing to everyone.

We never make an investment without having first screened, scored, ranked and filed it properly. Seeing the whites of the eyes of the managers we entrust with our client savings is a prerequisite, not a benefit of our size. Our approach to research is scientific, evidence based, asking pointed questions. We do our best to understand what we’re looking at before investing a penny. And then we ask more!

Keeping track of investments is as important as finding new ideas. We watch out for a wide range of risks: portfolios can get too concentrated, become increasingly illiquid, employ high leverage, be exposed to particular styles or factors, become unduly expensive, suffer from regulatory change and questionable governance, be exposed to environmental or social risks. Every year we conduct hundreds of meetings with managers and engage in thousands of emails and phone calls with investments in our client portfolios to make sure we’re up to date with what’s going on. We flag anything that looks unusual, which drives us to seek answers.

It’s a lot of effort. So why not just go passive? It’s easier, cheaper and certainly wouldn’t present the same governance problems we see from time to time in active fund management. The trouble is you only swap one set of risks for another. When the going is good, the risks matters less. But what happens when risk matters more? With passive investing, you are most likely investing proportionately to company size. That means more concentration in individual companies. If anything goes wrong with one of these larger companies, passives will be more exposed.

With bonds it often means investing more heavily in the debt of the most indebted companies, i.e. the ones most susceptible to defaulting on their obligations. Then there is the question of which passive fund to use. There are more than 50 of them tracking different parts of the UK equity market alone. They are available at low fees, but none of them offer any risk management.

There are a few signs warning of trouble ahead. It is in more troubled times that the benefits of active management, of putting the effort in, should bear fruit. After such a protracted bull market, people have forgotten what canaries look like, let alone why they’re in the coal mine.

Contact our team

Have a question about investing with EQ? Please email enquiries@eqinvestors.co.uk, we’re always happy to hear from you.

About the author: Kasim Zafar

Kasim graduated with a BSc (Hons) in Physics from Imperial College and is a CFA charter holder, being a regular member of the CFA Institute and CFA UK. He began his career in investments in 2002, gaining experience as a portfolio manager and senior analyst of global capital markets. His experience spans multiple asset classes, constructing portfolios with varying risk/return objectives and active risk management processes.

Kasim is the portfolio manager for the EQ Investors Best Ideas portfolios. He is an active member of the investment management, strategic asset allocation and fund selection committees.

When not immersed at work, Kasim often finds himself stumped and constantly amazed by his young daughter at home. He also enjoys spending time in the kitchen practising his “cheffy” skills with both European and Asian cuisine, reflecting his mixed background.