Standing on the shoulders of giants: Skandia’s EBI
The concept was simple: to find the best of the best ideas, from the best of the best managers. Investment Europe talks about structuring to Lee Freeman-Shor, manager of Skandia’s High Alpha Funds and the power behind the European Best Ideas Fund.
Sir Isaac Newton and Sir John Templeton, among other great thinkers, were the inspiration for the design of the Skandia European Best Ideas (EBI) Fund, according to manager Lee Freeman-Shor.
“If I have seen so far, it is because I have stood on the shoulders of giants,” Newton said.
Templeton said: “It is impossible to generate superior performance, unless you do something different.”
Freeman-Shor has a few skills himself. He is a keen poker player, ongoing academic and student of behavioral finance. It has proved an inspired combination, with the EBI fund, set up in April 2008, delivering top-quartile performance since launch.
The fund is the latest in a Skandia range that includes the UK Best Ideas and Global Best Ideas Funds. With the magic three-year track record just under its belt, having launched initially in Europe and the UK more recently, the EBI Fund has drawn in €430m, with €60m net new inflows this year.
From the start, Freeman-Shor wanted to blend the best long-only and long/short hedge fund managers, and their best ideas.
“Each manager is investing in their ten highest conviction stocks,” he says. “The overall portfolio is well diversified, but unlike other funds, the 90th stock is not someone’s 90th best idea. Every holding in the EBI fund is high conviction: no padding, no wasted capital.”
At the moment, the fund has nine managers and 90 stocks. Each manager can invest a minimum of 5% and up to 25% of their ‘pot’ in one stock. They are also allowed a maximum 25% cash holding for as long as they deem necessary. Few use it, except over periods of market stress. Crispin Odey did after Lehman in 2008, but in practice it rarely extends beyond a couple of months.
The four keys
The structuring of EBI is rooted in four key pieces of independent research.
The Kelly Criterion – or maximising the geometric mean – was first described in 1956 and has long been a favourite principle of investor Warren Buffett. It calls for managers to invest heavily in their best ideas to generate the highest possible returns. “It is a proven technique and is why I allow managers to invest up to 25% in one stock,” says Freeman-Shor.
Another paper, published by Randolph Cohen, Christopher Polk and Bernhard Silli (originally published in 2005 and updated in 2009) shows that the bulk of fund managers’ returns come from their highest conviction ideas. This is why Freeman-Shor limits EBI fund managers to just ten holdings each.
Research by Cremers and Petajisto (2009) suggests that running a fund with a high ‘active share’ delivers the highest and most repeatable returns. A book from the Yale University International Center for Finance, Buy & Hold Is Dead (Again) by Ken Solow of the Pinnacle Advisory Group, elaborates on the theory.
According to Solow, the highest-performing group of funds was the group with the highest active share, smallest assets and the best prior one-year performance. This group outperformed their benchmarks by 6% per year, even after deducting fees and transaction costs. Solow maintains that active share offers a better way to measure the performance of active managers, and is one that appears connected to their real-world experiences.