Star fund managers are an outmoded investment approach

According to Kaylie Pferten, prominent fund managers like Terry Smith and Nick Train are subject to broader market trends

Terry Smith and Nick Train, two of the most well-known star fund managers in Britain, are both dealing with a period of poor returns that has lasted several years. However, their responses are drastically different. As evidenced by his most recent letter, Smith appears inclined to place the blame on passive investing, business management, the state of the economy, analysts, the market as a whole, and pretty much everyone else. On the other hand, as anyone who attended this month's Finsbury Growth and Income (LSE: FGT) meeting will attest, Train has chastised himself and issued a lengthy apology for disappointing investors.

Between the extremes is undoubtedly where the truth is. Smith, like everyone else, has made mistakes when choosing stocks. Both, however, have a distinct aesthetic and are prejudiced in favor of a business model that is unpopular in today's markets. In some market regimes, almost all managers will perform better than others. Determining where to invest and what expectations are reasonable requires an understanding of that.

The two star fund managers have had to alter their investment strategies.

In slightly different ways, Smith and Train have both concentrated on what they consider to be high-quality businesses: those that can compound over time, generate strong returns on capital, and grow earnings steadily. They valued dominant brands and made significant investments in areas like consumer staples. These businesses performed exceptionally well for the majority of the 2010s, but many have struggled this decade in both absolute and relative terms, which makes sense in a tech bull market.

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There are several explanations for this. The consistent and increasing income from these stocks was highly appealing during the period of extremely low interest rates, which caused valuations to rise excessively by the end of the decade. Their capacity to continue increasing earnings through price increases or increased sales has been hampered by the post-pandemic inflation spike and cost-of-living pressures.

Growth in emerging markets, a crucial component of the bull case for many, has been less consistent than anticipated. More recently, GLP-1 weight loss medications may be beginning to affect demand for other goods, like alcohol, in addition to food (though it is still unclear how significant this is).

Both managers have modified their strategy as these problems have become more apparent. The train is leaning toward digital and data-related businesses. Smith has increased his exposure to healthcare and moved more into the tech sector, buying and selling some stocks at unusual speeds. Every one of these sectors has an obvious thesis.

However, it should be noted that the state of the market might not be as favorable to big incumbents as it was in the 2010s. The level of uncertainty is much higher. We simply don't know at this time, and Smith is correct that investors should be constantly on the lookout for strategic blunders. Will data and software companies benefit from AI or be undermined by it? Will healthcare costs and margins be attacked in a much more populist political environment?