Fund houses with impressive numbers over these periods make use of the figures as a marketing tool, and many IFAs and private investors use them as the basis for rating the portfolio.
However, three portfolios examined by FE Trustnet show that having one spectacular year can drag up a fund’s three- and five-year figures even when its performance in the other 12-month periods has been less impressive, and even poor.
Close Brothers Special Situations is perhaps the most extreme example of this phenomenon.
According to data from FE Analytics the fund made an incredible 246.87 per cent in 2009 – meaning an investor’s holding in December was three and a half times larger than it was at the beginning of January.
Performance of fund vs sector and benchmark in 2009
Source: FE Analytics
However, the fund followed that up with fourth-quartile returns in the two complete following years and in 2012 to date.
Despite this, at the beginning of 2012 Close Brothers Special Situations had the best three-year figures of any fund in the IMA UK Smaller Companies sector.
Performance of fund vs sector over discrete calendar years
| Name | 2012 returns (%) | 2011 returns (%) | 2010 returns (%) | 2009 returns (%) |
|---|---|---|---|---|
| Close - Special Situations | -6.7 | -14.48 | 24.03 | 246.87 |
| IMA UK Smaller Companies | 17.53 | -9.04 | 31.56 | 50.18 |
Source: FE Analytics
Although 2009 has dropped off the three-year figures, it still has an effect on the five-year figures, with the fund a top-quartile performer over that time frame, with returns of 40.97 per cent.
Manager Deryck Noble-Nesbitt was awarded a number of prizes for his work on the fund, based fundamentally on the performance over one year.
Performance of fund vs sector and benchmark since launch
Source: FE Analytics
Although it is true that the fund has outperformed its sector and benchmark over its life, the degree of outperformance is relatively modest, and investors relying on the five-year figures could be misled.
Noble-Nesbitt says that the economic environment has radically changed since 2009, explaining the dip in his fund’s performance.
"At the beginning of 2009, equities offered the kind of future potential returns only typically seen two or three times in a generation," he commented. "The environment for identifying special situations was, quite frankly, astonishing."
"The backdrop has been different during the last two years – buying companies that have seen steady upgrades to earnings has arguably been the most rewarding investment strategy."
"Buying small, unloved and undervalued special situations has been a less fruitful endeavour. I believe that the Close Special Situations fund contains significant amounts of long-term value and am confident that the strategy will come back into favour at some point."
"However, I am also conscious that the world faces a significant number of macro-economic challenges that could cause volatility in equities to increase in the short-term"
Another fund to be flattered by a spectacular year is MFM Slater Growth, managed by Mark Slater.
This is currently the best-performing fund in the IMA universe over three years, as highlighted in a recent article.
However, this is mainly due to its spectacular outperformance in 2010, when it was the biggest gainer in the IMA UK All Companies sector, rising 76.68 per cent.
The second-best performer in that year – MFM Bowland – made 40.36 per cent, a little over half the returns of the MFM Slater Growth fund.
Mark Slater's fund has a more consistent track record than Close Special Situations, being a top quartile performer in 2009 and 2011 and winning five FE crowns on the strength of this.
Performance of fund vs sector and benchmark over 5-yrs
Source: FE Analytics
Slater explains that for a value investor, the period just after the financial crisis was one of unprecedented opportunity.
"The massive gains are unlikely to reoccur unless we have another period of massive falls," he said.
Slater says the reason the fund did particularly well that year was because none of his holdings did badly, rather than because there were any standout risers, and that nothing has changed in his value-based approach.
"From the investor’s point of view the most important thing is that the fund is doing something sensible that they can understand," he explained.
The Legg Mason Japan Equity fund is another to have had barnstorming success in a single calendar year.
In 2011 it managed to make 27.07 per cent while the IMA Japan sector lost 11.76 per cent. Prior to this it had been in the bottom half of the sector for five consecutive years – with four of these spent in the fourth quartile.
Its recent success has elevated it on to the list of the top-performing funds in the entire IMA universe: between 16 November 2009 and 9 November 2012 it made 83.62 per cent, according to FE Analytics.
It is also the top-performing fund in the sector over three years and the second best over five, despite its underperformance in the earlier part of those periods.
Performance of fund vs sector and benchmark over 5-yrs
Source: FE Analytics
Ajay Dayal, investment director at Legg Mason, says the fund’s recent outperformance has been caused by a critical shift in the Japanese economy, meaning that its sector-leading returns should continue.
"We believe that the fund will continue to deliver solid long-term returns, because of its focus on companies that benefit from the secular changes that are happening in Japan and creating new growth sectors," he commented.
He explains that many of the portfolio’s mid-term holdings in the small and mid cap market have started to pay off in recent years, with one discount retail holding up 50 per cent over three years.
"Investor sentiment over Japan remains low among global asset allocators, who are underweight in Japanese equities," he continued.
"This is because we think they still look at Japan as a manufacturing and export-driven economy, not realising that its economic structure is changing towards a domestic demand and service-oriented one."
"The overall market, dominated by large cap manufactures, will remain sluggish, but companies of the 'new Japan' are expected to continue to show their strong performance."