One of my major irritations is our industry’s slavish focus upon past performance of funds and, in particular, quartile rankings.Nothing’s worse than when a fund salesman gets out a table of fund performance figures and tries to convince you that their fund is better than one of your selections, based upon past performance. To lay our cards immediately on the table (not the performance variety), we view the past as the past, not prologue, and we’re with the FCA on this one. We would advise other investors and our clients to think similarly.
In practice, the only thing we use past performance of potential additions to the Psigma buy-list for is to analyse in what conditions the manager’s strategy has added value and how that fund may blend with others in different market scenarios.
This accounts for about 15 per cent of our total analysis of a fund’s suitability for our portfolios and is still only considered a rough and imprecise guide.
But it can help, and as a recent example, we added Peter Kaye’s Fidelity American fund to our buy-list in January, recognising his ability to identify earnings surprises in the late part of an equity market cycle.
Performance of fund vs sector and index since Jan 2012
Source: FE Analytics
This helped him to outperform strongly at a similar stage of the last bull market in 2005 to 2007, but this of course is by no means a guarantee that he will perform as well in the comparable conditions we see going forward.
Fund-pickers try to put a lot of science and quant analysis behind fund picking, but in terms of long-term performance in the rear-view mirror, we have found no obvious link to a manager’s ability to outperform in a future investment cycle.
In fact, it can be totally misleading.
Shorter bursts of performance may be easier to identify, but the basic rule is that it is vital that investors focus instead on the things that really drive future returns: process, philosophy and positioning.
This emphasis allows our investment process the flexibility to invest in new funds and seed exciting new funds, as we did successfully with River & Mercantile’s UK Long Term Recovery fund in late 2008 and, more recently, its World Recovery fund in May 2013.
Performance of fund vs sector and index over 5yrs
Source: FE Analytics
However, we appreciate that for individual investors it is nigh on impossible to glean the necessary information on a fund manager, although asset managers’ websites and information are improving from low levels.
To use a recent example of why we only use past performance as a small part of our assessment, our choice to select the Neptune European Opportunities fund last summer raised eyebrows.
The manager, Rob Burnett, had a great track record for the five years to mid-2012, but had seemingly fallen on hard times. Heavens aloud, he had even fallen down the quartile rankings of the IMA Europe ex UK sector. Thorough analysis of his positioning and three meetings with the manager revealed that he was invested in all the areas where we wanted to be: namely financials, industrials and consumer discretionary companies.
If European equities finally returned to favour, his strategy would act as leveraged beta to a recovering market. The fact that he had been early in to this trade was an irrelevance to us and, more importantly, our clients’ future returns.
Rob has been totally right for the last six months and we have benefited.
Performance of fund vs sector and index over 6 months
Source: FE Analytics
Generally, quartile rankings also make me cringe and can be misleading for investors.
If one takes the UK All Companies sector as an example, how can you really compare a UK recovery fund with a small cap bias to a core UK benchmark-aware fund, as the sector does? Indeed, this is utterly deceptive and can entice would-be investors in to the wrong funds at the wrong time or out of the right fund at the wrong time.
This is the main reason why we see much of the analysis bandied around our industry as total nonsense. The worst offenders are the IMA Mixed Investment sectors, but in truth they all have severe limitations.
Comparing the aforementioned R&M Recovery and Neptune European Opportunities funds to their respective benchmark indices, FTSE All Share and MSCI Europe ex UK, as well as their sectors, IMA UK All Companies and IMA Europe ex UK, is nonsensical.
Because of their latest positioning and their managers’ respective philosophies, they will massively outperform in positive conditions, but will likely wildly underperform if investors start to panic or economic data disappoints. You don’t need quartile rankings to tell you this.
Our process predominantly selects funds to do a specific job within portfolios and we assess performance based upon a number of qualitative and quantitative factors.
However, a forward-looking investment process must focus its analysis upon the drivers of future performance.
I note with interest that Hargreaves Lansdown’s highly publicised Wealth 150 Plus list was launched with comments that all of the selected funds had beaten their benchmark over the long term. My response would be “who cares?”
Tom Becket is chief investment officer at Psigma. The views expressed here are his own.
