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Spotting a dog: How to tell if you’re in a bad fund

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The annual Tilney BestInvest 'Spot the Dog' list has revealed that UK investors are holding nearly £23bn in underperforming collective funds.

The list of culprits highlighted poor performance from heavyweights M&G, Aberdeen and Newton.

Reading that their fund has underperformed can seriously test the faith and patience of an investor but it does not necessarily mean it is time to sell-out.

There are a number of reasons funds underperform and identifying the cause should be the first step taken by worried investors.

Why do funds underperform?

There are two key reasons for a fund manager to underperform – either their style is out of favour with the market, or they are a bad fund manager. Deciding which it is will determine whether an investor will sell or hold out for better times.

However, it is not always clear which it is: For example, Tom Dobell, manager of the M&G Recovery fund, a long-time investor favourite, has struggled with a period of underperformance compared to his peers and once again features on this biannual ‘dog list’. His underperformance has been attributed to the fact that his style was out of favour. He was held back by a lack of merger and acquisition activity and the weak performance of ‘value’ stocks.

But many of these problems have reversed and there is still no sign of any meaningful turnaround in performance. Jason Hollands, managing director at BestInvest, said: “The run of underperformance is particularly disappointing given half the fund is invested in small and mid-cap stocks, parts of the market which have performed well in recent years.” He said Dobell’s fund had “seriously tested” investors’ patience.

There are examples of great managers who have just had difficult periods: Invesco Perpetual’s Neil Woodford and Fidelity’s Anthony Bolton are two examples of top fund managers who have experienced dips in performance throughout their careers. This proved to be down to style, rather than they had become bad managers.

“They are contrarian or value managers so are looking for investments whose full value is not appreciated by the market. It can be very lonely being a contrarian and investors need to be patient which is tough,” Adrian Lowcock says.

Of course, some times the manager is entirely at fault. They could have made bad stock picks, miss-timed the market or simply got their asset allocation wrong if they run a more diversified fund. Investors need to decide whether this weakness is permanent or temporary.

Currencies can also play a negative role in the performance of a non-UK fund.

Time to jump ship?

Darius McDermott, managing director of Chelsea Financial Services, says investors should consider a number of factors before ditching a poor performing fund.

First, he suggests asking the manager to explain the underperformance: “If the manager can’t articulate why, to me this is a warning sign. If the manager can explain the underperformance and how they think it may turn around in the future, and the investor is happy with the explanation, they may decide to stick with the fund.”

He also believes investors should consider the longevity of the manager: “I’d give a more experienced manager with a track record more breathing space if they had a year or two of underperformance than I would a new manager who has only been investing for three years, for example.”

Lowcock, meanwhile, suggests investors ask themselves whether the manager is actually underperforming.

“Check against the right benchmark,” he says.

“For example, a manager only investing in FTSE 100 companies will have looked bad for the past decade compared to the FTSE All Share but this is not a fair comparison. Also check how their peers have done. Look at sector peers as well as those with a similar investment style. If the environment has changed have they adapted to it the other manager not?”

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