A look back on the first year (or so) of the Downing Fox Funds

It’s been a year since we launched our funds and moved into our farm-based Den of Research – time for a progress report.

We have a double anniversary to mark: The VT Downing Fox Funds have just passed through their first year; and it’s been 12 months since we established our rural Downing Fox Den of Research. This is in a working barn far from the madding crowd of London, which – now we’re used to the occasional bouts of mooing - has been a godsend for helping us concentrate.

If you’ve heard from us before, you’ll know we love a metaphor, and the farming-investing one is too good to pass up. So, through the farm’s lens, we’ll look at the funds’ first year: What have we been doing? What has worked? And what hasn’t?

Setting the farming scene

The first main-stage presentation I gave during a successful run in a previous role at PremierMiton was called ‘Farming for Alpha’. It looked at the parallels between how I invest and how they farm in, of all places, Papua New Guinea.

We used Papua New Guinea because it provided a rare example of how humans used to farm before industrialisation: In the 1930s, when the first Western explorers reached the remotest New Guinean communities, they were baffled as to why they farmed so inefficiently: Families would tend several plots, each growing different crops and all miles apart.

To the mid-20th-Century Westerner this was laughable: The benefits of scale and specialisation were obvious, so why would you a) choose not to focus all your expertise on one type of crop? And b) waste your time travelling between scattered small plots when you could intensively farm a single super-field?

But the visitors eventually figured it out (largely from disasters caused by trying to modernise the Indigenous farmers): The locals’ approach was a form of risk management – one that had been honed over thousands of years of trial and error.

The Western commercial farmer’s approach is to produce the maximum amount of crop over a long period (say ten years) – so they’re aiming for a high average annual output. Average, because they will likely produce stunningly high crop yields in eight or nine of those years, which will more than compensate for the one or two years which turn out to be washouts (due to weather, pests, disease etc).

But for a subsistence farmer, this approach is suicidal: They’re growing food to see them through each and every year. If they relied on a single super field, and in one year it fails, it doesn’t matter how good the following nine turn out to be because they’ll have starved to death¹. So they diversify: By both crop type and location.

This ties in with the basic concept at the heart of Downing Fox:

It’s no use producing incredible performance four years out of five if the other year is so bad it makes holders sell the fund.

This is why each Fox Fund is a diverse farm: They hold a multitude of different (but proven) strategies, each aiming to maximise its returns over the long term (usually five years or more). And as each one is a focused specialist, they should produce that mix of really good and really bad years² (this is a feature not a flaw of great equity investors – see Warren Buffett).

The trick is to pick strategies whose good years add up to more than the bad, and to ensure that, from a Fox Fund perspective, all their bad years don’t come at once. If we do this, we should avoid the overall portfolio experiencing a catastrophic year, thereby distressing our holders so much that they abandon their long-term investment plans.

In this way, we combine the benefits of specialisation with the resilience of diversity. In investing as in commercial farming, this turns out to be a weirdly unusual thing to do.

Our first year

The first year for the Fox Funds has been a good one – they’ve all produced decent positive returns, so our early holders have more money than they started with:

You might even call this a great vintage: If Fox100, for example, produces 13% a year for the next 20 years we’ll be pleased: Our families will eat well and prosper.

Why have they done so well?

Largely because growing conditions have been kind: In financial markets, the sun has shone, the rain has watered, and almost all crops have produced decent yields. At the outset, we committed the Fox Funds to staying invested by fixing their equity weightings and stating that in their fund names: This prevents us from panicking into planting more or less than we should because of a spurious weather forecast. Few of our competitors, especially ‘active’ ones, make the same commitment).

In fact, a cynic might point out that, in this particular 365-day period, our total tonnage was somewhat less than average. Which it was. But we are comfortable with this. Why?

Because the wealth management industry is, we feel, moving ominously towards the monocrop model, where they increasingly focus their clients’ capital in just one type of asset. This means that when this monocrop has a bumper year, it will produce a higher tonnage than a more diversified approach like ours. And if it does that for several years in a row, then more farmers will abandon the old, diversified approach and focus increasingly on harvesting just that one super crop.

Of course, the trouble comes when there’s a problem with that monocrop – that could be disastrous (Ireland’s potato famine was a devastating agricultural example).

Fund ‘style boxes’ are a good way of illustrating investment diversity (and extend our farm metaphor by looking like a birds-eye view of a landscape). Here is the map of the ten funds in the IA Global sector that produced the highest tonnage during our first year. That they are all ploughing exactly the same furrow – ‘mega-cap growth’ – suggests this has less to do with manager skill than it does market conditions happening to suit their particular crop:

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The dangers of monocropping

Interestingly, many Western farmers have begun to shift back towards traditional farming techniques. There’s a growing belief that while heavy monocropping will produce blockbuster yields for a while, this comes at the expense of, at best, degraded future fertility and, at worst, a complete collapse of the ecosystem.

Clarkson’s Farm and The Biggest Little Farm are entertaining examples of farmers beginning to reintroduce diversity. Their belief - backed by mounting scientific evidence - is that this produces good yields that are sustainable over the long term and help avoid a devastating future collapse.

Sustainable over the long term’ and ‘avoiding devastating collapse’ also happen to be mantras for us: They are sensible, achievable investment goals. So, unsurprisingly, Downing Fox is set-up in a genuinely diverse way. Here’s how our farm of funds would look through the eye of a passing blue tit:

Swanlike?

This level of diversity is having a measurable effect. Not yet in terms of outperformance, although we believe that will come, particularly when we see conditions that don’t suit the popular mega-cap monocrop. But it is showing up in the Fox portfolios’ volatility.

We don’t try to ‘manage’ volatility, particularly not over a period as short as a year. And we don’t try to fill our portfolio with subdued ‘core’ funds to dampen the ride – quite the opposite: The VT Downing Fox 100% Equity Fund is, as the name suggests, always fully invested in equities and is filled with fund managers who are swinging for the fences. Furthermore, it holds a decent slug of small-cap and emerging-market strategies – areas commonly thought to be riskier and therefore more volatile (I dispute that they’re more risky – but that’s for another note).

Yet despite that, of the 537 funds in the IA Global Sector, ‘Fox100’ was the fifth-least volatile fund over its first year (see tables below).³  This slots us between several funds whose names suggest they are specifically trying not to be volatile:

It’s also interesting to look at what sits at the most volatile end of the rankings. Again, look at the names: They’re volatile because they’re focused on one sector, making them specialist producers, not diversified farms.

By the way, neither table tells you if a fund is good or bad: Volatility is a flaky-at-best proxy for actual risk, and you certainly can’t feed your family with it. But I do take it as a healthy sign that our funds are genuinely diversified⁴, and that this diversity will make for funds that will survive and thrive (you can’t have the latter without the former, not over the length of time it takes to grow a pension, anyway).

That’s enough on the big-picture stuff – feel free to head off now if you’ve had your farming fill (exit via the farm shop). But those of you who’d like to stay on for a tour of our fields are welcome to.

Outstanding in their field? A wander through Fox Farm

How about we start in our mid-cap growth paddock? It’s home to one of our best performers of the year, so it’s as good a place as any.

Among others, this paddock is home to Spyglass US Growth. It’s run from San Francisco by Jim Robillard. He and his team are looking for 25 outstanding smaller or mid-sized companies that – they believe – will grow to be at least four times bigger over the next ten years.

25 is a relatively low number of holdings, and fast-growing companies like that can be volatile. And so, by extension, is Jim’s fund. Sometimes that’s ‘upwards’ volatility, which is a joy to behold. He’s just had one of those years, and it led to a bumper harvest, see chart:

“You fools!” You may be thinking, “Why didn’t you just put everything in Jim’s paddock?!”

Because sometimes he’ll experience ‘downwards’ volatility, which is mightily tough to behold. And we, Jim, and everyone else don’t know which year will be ‘upwards’ and which ‘downwards’ (just as farmers don’t know if the coming year will be outstandingly wet or dry). 2022, for example, was a downwards vintage, and precisely none of our investors would have thanked us for putting all their capital in Jim’s fund that particular year:

The golden field

As we wander northwards, we enter the field that, as mentioned above, has produced the highest yields of late. At this year’s county show, our entrant in the ‘biggest mega-cap-growth pumpkin’ competition will be Sanlam Global Artificial Intelligence (if you look at the earlier style map, it’s the furthest right of the large-cap-heavy funds).

Of our current holdings, this was the year’s top performer. It’s a great fund, managed by an excellent manager (we won’t hold anything else), but it was also helped by the year’s conditions, which saw the start of a frenzy for all things AI (artificial intelligence). It won’t be this good every year:

This AI-focused fund is a good one to highlight, as I don’t want my talk of traditional farming to suggest we’re anti-progress luddites favouring oxen and ploughs over tractors: Not all progress is bad.

It’s also useful to point out Sanlam’s fund is not a ‘smart beta’ play. We don’t hold that stuff: We ensure the (human) manager who’s selecting the stocks is top-drawer first of all, then establish that, if they are thematic in nature, their theme is a viable one. All boxes were ticked for Chris Ford and his impressive fund.

Locally-grown produce

Both of these prize specimens are all, or close to all, invested in overseas equities, particularly US equities. Not a surprise when you consider how well US shares fared, especially compared to the beleaguered UK. Given that headwind, it’s good to see a UK equity fund make our top-five producers for the year.

To view this fund in its field, we’ll have to cross to the opposite part of the farm; The small-cap value meadow. Looking at the earlier map again, the Dowgate Cape Wrath Focus Fund is the bottomest and leftest of all of our fields.

Like Spyglass, Cape Wrath is one spicy meatball of a fund. If you held this and nothing else, your hair (assuming you have any left) would turn white. Its manager, the ex-military, Atlantic-rowing, mountain-running, philosophising Adam Rackley, would tell you as much himself. He holds around 23 stocks, almost all of which are small caps that are, for one reason or another, disliked by the market.

A well-run ‘small-cap value’ fund, which is what this is, can make you an awful lot of money over the long term – I love them - but it will swing around a lot while it’s doing it.

The reason our hair remains, so far, in place and not-quite-white (yet) is because we hold this fund as part of a diversified portfolio. In fact, we often find that many of our holdings have an equal-and-opposite holding that acts as a foil. Adam’s fund blends beautifully with another home-grown classic – VT Castlebay UK Equity. Showing how they work together helps to explain why the Fox Funds can run so smoothly when they’re stuffed with full-bodied active funds:

As you can see, it wasn’t a vintage year for Castlebay. Its manager, David Ridland, runs what we’d call a quality-growth strategy, which is about as ‘slow and steady’ as we get. This type of fund hasn’t flourished amid the conditions of the last 12 months.

But, when paired with Cape Wrath, it was a perfectly good year for the blend. Most importantly in terms of returns produced, but it also helped by reducing any stomach-churning swings in performance: The upswings of one usually counter the downswings of the other. This ‘relative’ performance chart (when their line is rising they’re beating their sector average, when it’s falling they’re lagging it) better shows that in action. Note how the ‘blended’ line is considerably smoother than either of the two funds that make it up:

Now add another 37 funds to that portfolio, spread across different markets, company sizes and investment styles, and you will have a fair idea of what the Fox100 portfolio is.

Activity

Farming is a great way to think about how we manage the funds. It’s easy to imagine multi-asset portfolio managers spending all their time studying economies, politics and markets (i.e. ‘the macro’) to know how to perfectly position for the coming conditions. It’s easy to think that because that’s what many portfolio managers tell you they do.

In my eyes, that’s like a farmer not tending their crops, but spending their working year trying to figure out next year’s weather. Which is to say it’s a giant waste of time. Markets, economies and societies follow the same chaotic laws as the weather, which makes trying to predict them a fool’s errand. This is why we don’t spend time doing it.

Instead, we constantly tend our holdings. That means meeting with the managers to ensure they’re still fit for purpose. Or scouring the market for new funds that are either better than an incumbent or add something we didn’t have before. Naturally, there’s more to it than that, but not much more.

In year one, we added plenty of new funds – 14 of them to be precise. Over the same period, we let five of them go. The mathematicians among you will work out that means we have many more funds than we started with. This was always the plan for our early years. As we meet more managers that are a) great and b) willing to manage at our challenging price point (all benefits passed onto our investors – it’s part of how we’re making funds-of-funds competitive again), we were always going to add more diversity to our ecosystem.

The other reason is that Alex Paget, my co-manager joined early in 2023, which means we now have two farmers instead of one. We think we can tend about 20 funds each before we start to become overwhelmed. We’re pretty much at that now, so any new arrivals will have to be matched with a departure. Not easy, but a good discipline.

Defence

What we haven’t done, of course, is mentioned our non-equity holdings (the water to our whisky). These are a different kettle of fish, run with an all-out defensive mentality. We’ll save a deeper dive on this for another time.

But in summary, our ‘Defence Component’ has continued to do its job. But in a year in which equities were the star players, it has drifted into the background; as it should. Frankly, after its heroics in 2022, it has earned the right to a little rest and recuperation. But be assured that it’s ready for winter to descend onto equity markets once again (whenever that might be).

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The outlook

Unsurprisingly, given all we’ve said above, we’re not going to tell you what markets will do over the next year. However, what we can say is that, in most of our fields, the ground looks mighty fertile: In equity markets across the world, when you remove the mega-cap growth stocks - which have run hard for many years now and look expensive as a result - valuations look good. So there’s no reason to think our farm can’t produce fantastic returns over the coming years.

And even in the top right field, which is looking a little exhausted after several bumper years, we’re confident our specialists can eke out decent returns by avoiding the worst parts and seeking out the remaining good bits. In other words; they can sort the wheat from the chaff.

This is why I’m fully invested in the Fox Funds with my own money, and my family’s money too. It’s what they’re for.

If you’d like to know more, or sign up for future crop reports, please let us know. And if you’re passing by the farm, please pop in for a chat.

Good luck out there,

‍Simon Evan-Cook
Fund Manager, Downing Fox

Find out more about the VT Downing Fox Funds range.

References

^1. The investor Howard Marks is fond of an adage that illustrates the same thing: Remember the six-foot person who drowned crossing a river that was – on average – five feet deep.
^2. We can also help sustain our farmers/fund managers in their lean years: Because we’re committed to hold them through thick and thin, through portfolio rebalancing we send them more capital in the fallow years, which helps to keep them operating when most other investors are pulling capital out (and thereby missing out on the better returns that come when conditions improve for them again). We really are serious about the ecosystem thing.
³. I only found this out by accident. I was explaining to a potential investor our ‘full bodied’ approach, to which he replied “Wow! Sounds punchy!”. I suggested not, but after the call I looked up the numbers. I know from running this approach before that it’s quite the opposite, but even I was surprised at how smooth the ride has been.
^4. I’ve always been mildly obsessed by running portfolios that hold up well in downturns, largely because I think a good way to make money is not to lose it in the first place. I expect our diverse mix to, over time, prove resilient, and that’s certainly showing through when markets are selling off.

Opinions expressed represent the views of the fund manager at the time of publication, are subject to change, and should not be interpreted as investment advice.

Important notice: this document has been prepared for professional investors and has been approved as a financial promotion in line with Section 21 of the FSMA by Downing LLP (“Downing”). Capital is at risk and investors should note that their investments and the income derived from them can fall as well as rise and investors may not get back the full amount invested. Past performance is not a reliable indicator of future performance. Any subscription to the fund should be made on the basis of the relevant product literature available from Downing or from the ACD, Valu-Trac; and your attention is drawn to the charges and risk factors contained therein. Downing does not offer investment or tax advice or make recommendations regarding investments. Downing is a trading name of Downing LLP. Downing LLP is authorised and regulated by the Financial Conduct Authority (Firm Reference No. 545025). Registered in England and Wales (No. OC341575). Registered Office: 3rd Floor 10 Lower Thames Street London EC3R 6EN