What 2 top-performing funds have in common

The Mawer Global Equity Fund and Fundsmith have handsomely outperformed the market since inception. Here's how they did it.

If you thought that professional investors can easily beat an unmanaged basket of stocks, think again.

According to an article on CNBC, 64.49 per cent of large-cap funds lagged the S&P 500 in 2018. It marked the ninth consecutive year that actively managed funds trailed the broad US-market index.

Over a 10-year period, 85 per cent of large-cap funds underperformed the S&P 500. Over 15 years, that figure increases to 92 per cent.

Given how such few funds consistently beat the market, I tend to take notice when one does.

Two funds, in particular, have caught my eye. They are the Fundsmith Equity Fund and the Mawer Global Equity Fund. Both funds have global investment mandates and have beaten their respective indexes by a wide margin.

Fundsmith has an impressive annualised return of 18.3 per cent as of 31 Oct 2019 since its inception nine years ago. It is well ahead of the annualised 11.7 per cent return of the global equities market. 

The Mawer Global Equity Fund has also done really well since its inception in 2009. As of 30 Sept, it has a compounded annual return of 13.1 per cent, compared to an 11.4 per cent return from the global equity benchmark.

So what is the secret behind their success? 

LOW PORTFOLIO TURNOVER

Needless to say, careful selection of high-quality stocks is one of the key ingredients to their success. 

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But another thing that stands out is that both Fundsmith and Mawer Global Equity Fund have extremely low portfolio turnover. Portfolio turnover is a way to measure the average holding period for a stock in a fund.

In 2018, Fundsmith and the Mawer Global Equity Fund had an annualised portfolio turnover of 13.4 per cent and 16 per cent respectively. In essence, that means the average holding period for stocks in their portfolios was more than 6 years each.

So why is this important? Terry Smith, founder and manager of Fundsmith, explained in his annual letter to shareholders that a low portfolio turnover "helps to minimise costs and minimising the costs of investment is vital contribution to achieving a satisfactory outcome as an investor."

Besides reducing the costs of transactions, staying invested in high-quality stocks gives investors the opportunity to participate in the immense compounding effect of the stock market. 

Morgan Housel, currently a partner in Collaborative Fund, wrote in one of his past columns for the Motley Fool:

"There have been 20,798 trading sessions between 1928 and today (2011). During that time, the Dow went from 240 to 12,500, or an average annual growth rate of 5 per cent (this doesn't include dividends). If you missed just 20 of the best days during that period, annual returns fall to 2.6 per cent. In other words, half of the compounded gains took place during 0.09 per cent of days."

Hence, a low portfolio turnover not only reduces transaction fees but increases the chance that investors do not miss out on the best trading sessions, which form a large portion of the market's returns.

LOW MANAGEMENT FEES

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Actively managed funds have been known to charge notoriously high fees. This is one of the reasons why active funds find it difficult to outperform their low-cost index-tracking counterparts.

However, both Fundsmith and Mawer Global Equity Fund buck this trend. Both funds have relatively low management fees and do not have a performance fee.

Fundsmith's management fee ranges from 0.9 per cent to 1.5 per cent, while Mawer Global Equity Fund has a management expense ratio of around 1.3 per cent.

THE GOOD INVESTORS' CONCLUSION 

When Warren Buffett was the manager of the Buffett Partnership some 50 years ago, he noted that earning a few percentage points more than the market average per year can be hugely rewarding. He said:

"It is always startling to see how a relatively small difference in rates add up to very significant sums over a period of years. That is why, even though we are shooting for more, we feel that a few percentage points advantage over the Dow is a very worthwhile achievement. It can mean a lot of dollars over a decade or two."

Actively-managed funds that can consistently outperform the market over a long time frame are a dime a dozen. But if you find one, it definitely pays to invest in it.

This article was first published in The Good Investors. All content is displayed for general information purposes only and does not constitute professional financial advice.