How much attention should you give fund sell-lists?
Dog lists, black lists, relegation zones; there are all manner of lists from adviser firms aimed at identifying underperforming actively managed funds.
One of the most high profile of these lists is Tilney Bestinvest’s twice yearly Spot the Dog report, which is full of metaphors comparing underperforming funds to hounds, and rounding up those fund management houses with the most ‘dog’ funds and putting them in the ‘doghouse’ for all investors to see.
The aim of this name and shame exercise – the Spot the Dog report targets those funds that have underperformed for three consecutive years and by 10% over three years – is to encourage investors to review their investments so they don’t stay stuck in perennially underperforming funds. According to its latest Dog report, there were 54 consistently underperforming funds, with some £18bn of assets sitting in the doghouse.
Jason Hollands, managing director at Tilney Bestinvest said: “It’s a simple fact that many funds fail to beat their benchmarks over the long run, after all the fees have been taken – investors need to consider their fund managers carefully. Surprisingly, many continue to put up with weak or pedestrian performance and it’s the fund management companies that benefit.
“The point of the report is that if you hold one of these funds then you should explore further whether or not to persevere with it or consider a switch. As we explain in the report, a poor performer might be worth sticking with if the fund has come under new management or its underperformance may be because of a style bias that has been out of favour but could be suited to changing market dynamics.”
In the same week Tilney published its list of hounds, Sanlam published its bi-annual study of the best and worst UK Equity Income funds, known as the White and Black lists.
Run for over 30 years, it ranks funds based on performance in terms of absolute income generated over the past five years, capital growth over the past five 12-month periods and volatility. Funds that make it onto the white list have produced superior total returns while the grey list can be an early warning sign for investors that a fund’s in decline. The black list houses consistent underperformers, and unless swift action is taken, it’s a sign for investors to look elsewhere.
But how much attention should investors pay to these sell lists, and does past performance tell you everything?
Well not according to the old Financial Services Authority (sorry Financial Conduct Authority now) mantra which always cautioned that ‘past performance is no guarantee of future performance’. Typically that mantra was applied as a way of cautioning that a fund which has done well in the past may not continue to do so, but the same can be applied in the opposite direction.
John Husselbee, head of multi asset at Liontrust Asset Management, says that measuring the performance of a fund manager by performance only is like “measuring the quality of driver by MPH only”.
“Active management is a long distance race not a sprint,” says Husselbee. “You also have to consider the process of the manager, their conviction, consistency and their courage to take bets versus the market and their peers. The longer the time period you measure this, the more certain you can be of their prospects for outperformance.”
The problem for Husselbee with many of the sell lists is that they encourage a short-term attitude among investors, in which they buy funds at the top of the market and sell them at the bottom. That is, the buy funds which are performing well at the time (maybe off the back of a group’s buy-list) and then sell them when they are underperforming (because of a sell recommendation).
“The search for consistency of performance is this industry’s holy grail,” he says. “I recently reviewed a 10 year period for IA UK All Companies sector and found that about one third of all managers outperformed the FTSE All-Share over that period. However break that down into 10 time one year periods, and most of those outperforming long-term managers underperformed in four out of the 10 years.”
As a result Husselbee says investors looking for outsized performance need one thing more than any other, patience. That is looking over the long-term and judging fund managers over full market cycles of seven-to-10 years, not three or five.
Indeed in an effort to reverse buying high and selling low, Husselbee says these sell surveys perhaps highlight the funds investors should be buying rather than selling.
“If a fund manager appears on the list, but has proven long-term performance and a consistent investment process, and are simply out of favour with the market, it could represent a good indication of value and a time in which to invest,” he says.
So in the absence of relying of performance-based sell lists, what should investors be looking out for that tells them a change of fund may be needed?
Today the fund rating firm Morningstar published a note downgrading its rating of the Newton Global Income fund to ‘Neutral’ following a recent change in its lead manager. Previously holding a ‘Silver’ rating when managed by its former manager James Harries, the rating was initially placed ‘Under Review’ when a new manager was put in place following Harries’ departure from the firm.
Now under the stewardship of Nick Clay, the previous alternate manager, Morningstar says it downgraded the fund to give it time to assess how the new manager will fare without Harries.
Husselbee says: “These notes tell you more about what is going on with a fund in terms of a change in process or team, which for us is of more interest and importance than shorter term performance issues.”