Wirecard scandal: Should fund managers bet big?

“The biggest mistake I've made” is how Alexander Darwall, manager of the European Opportunities Trust, described his decision to invest in German payments provider Wirecard as he offloaded his stake in the business last week.

Until last week Darwall, who left boutique fund group Jupiter last year to set up his own investment firm, had more than 10 per cent of the EOT portfolio invested in the German company – equivalent to around £80 million ($144 million). A stock market announcement on Thursday confirmed the manager had sold all of his shares in the business. 

Wirecard is currently embroiled in a scandal, as it emerged that £1.7 billion listed in its accounts may not actually exist. Shares in the payments group plunged 60 per cent in a single day on the news.

The effect of this on a portfolio with such a large stake in the company, such as Darwall’s, is huge. Morningstar data on 18 June, as the stock went into freefall, showed the trust – which is listed on the FTSE 250 – was down more than 11.5 per cent.

5-day stock price and trading volume | Wirecard AG (WDI)

Source: Morningstar Direct

A concentrated approach

Many investors purposely seek out managers with a high-conviction approach, taking big bets on the businesses they believe will thrive over the long-term. Such managers are often notorious for having incredibly concentrated portfolios.

But when these managers get it wrong, the ramifications on returns can be significant. It begs the question: should fund managers be betting big?

Jon Miller, head of manager research at Morningstar UK, says: “Managers with concentrated portfolios are by nature making key stock specific calls. Clearly, they’ll be doing something different than the index, meaning the potential upside and downside versus the market can be pronounced.”

A number of fund managers are noted for their bold calls on the companies in which they invest. With just 10 holdings, and almost 90 per cent of its assets it the top 10 holdings, the Magellan High Conviction fund is among the most concentrated Australian funds. Top holdings include US technology giants Microsoft Corp, Facebook, Apple and Alphabet, alongside financial services giant Visa and healthcare firm HCA Healthcare.

Gold-rated Greencap High Conviction also manages a concentrated portfolio holding 39 equities. Up to 45 per cent of assets are in the top 10 holdings.

Selection of Morningstar medallist concentrated equity funds

Source: Morningstar Direct

For investors, such a setup plays out incredibly well while a manager is making the right calls. Since inception in 2013, Magellan High Conviction has delivered annualised returns of 14.65 per cent against a category average of 11.30 per cent. 

The danger of getting it wrong

But when fund managers make a wrong call, these stellar returns can collapse. Darwall has managed the UK-based European Opportunities Trust (formerly the Jupiter European Opportunities Trust) since 2000. Over 10 years, it has delivered annualised returns of 14.22 per cent - more than double its benchmark - and over three months it is up 25.44 per cent. 

Darwall first invested in Wirecard 13 years ago, when shares were around €9, increasing his stake over time, and started to reduce his position in November 2017, when shares hit €121.

But concerns about Wirecard have been circling for some time, with persistent suggestions that some of the company’s reported revenues and profits were not reliable. While Darwall reduced his holding in the firm from around 15 per cent of assets to 10 per cent, he continued to stick with the stock. Morningstar Direct data shows that as of 18 June, the trust was the seventh largest owner of the business, with a 0.93 per cent stake.

It is not the only big bet in the portfolio. The trust’s top 10 holdings account for almost 80 per cent of assets including 10 per cent in Experian (EXPN), 9.9 per cent in Novo Nordisk (NOVO B) and 9.5 per cent in RELX (REL).

Certainly, the situation raises again the question of whether fund managers who set up their own investment firms can replicate the robust checks and balances that are in place at the investment giants where they have cut their teeth. It’s an issue which was cast into the spotlight with last year’s Woodford Equity Income collapse, when many questioned whether the fund would have been able to get into such a situation had the manager still had to hand the oversight of his previous firm Invesco.

Ben Yearsley, director at Shore Financial Planning, says: “Fund managers having large positions in their portfolio isn’t an issue as long as they’re clear that that is their style. Many of the best-performing funds have a concentrated portfolio and, unfortunately, occasionally they get something wrong, as in this case. Short-term, that clearly dents performance, but the key is getting it right more than wrong over the longer-term.”

Magellan High Conviction has stumbled amid the coronavirus market falls, returning -5.28 per cent this year and underperforming the category by -1.85 per cent. Morningstar senior analyst Andrew Miles says the Silver-rated strategy is a high-calibre option, but warns investors to brace for higher volatility, and use the strategy as a limited component of a broadly diversified portfolio.

"While this period is short and unusually volatile, divergent performance from the index is expected in such a concentrated product, which is why we recommend investors use the strategy sparingly," he says. 

Devon Equity Management did not comment. 

- Additional reporting from Morningstar Australia, editor, Emma Rapaport. A version of this article first appeard on Morningstar.co.uk.