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When you know it’s time to sell out of an underperforming fund

18 June 2014

Investors should be wary of selling out of a fund just because it has underperformed, but Whitechurch’s Ben Willis says sometimes action needs to be taken.

By Joshua Ausden,

Editor, FE Trustnet

Fund management is a results business, and if a vehicle falls behind its sector and benchmark over a significant period of time, criticisms are inevitable and often deserved.

ALT_TAG The controversy here is the definition of significant; some genuinely long-term investors would shrug off five years of cumulative underperformance, while others jump on managers who have dropped into the third quartile over six months.

The key is putting underperformance into perspective, understanding exactly why the manager has fallen behind – especially when the fund in question is less concerned with quartile performance and more with hitting a particular objective.

However Rob Gleeson (pictured), head of FE Research, says that there are signs that should send alarm bells ringing.

“We get concerned when the fund behaves in a way that we wouldn’t expect,” he explained.

“When we construct portfolios, we buy managers with certain styles and biases that perform better in some markets than others. You don’t want all funds to be the same, because then if something goes wrong you’re left totally exposed.”

“It’s when a fund that who expect to hold up well in a market downturn falls further in a sell-off that you should worry, or likewise if one that you expect to outperform when markets rally can’t keep up.”

“Indeed, if a fund that you expect to have defensive qualities performs brilliantly in a fast rising market, this too should send alarm bells ringing. The key is to understand the process, and making sure the manager delivers it.”

In a very broad sense, it is possible to categorise some funds as being suited to rising and falling markets. Managers with an emphasis on capital protection in the UK equity sectors such as Neil Woodford, Fidelity’s Michael Clark and Liontrust’s Anthony Cross, for example, tend to perform best during sell-offs.

However, those with a multi-cap focus that are more prepared to take advantage of cyclical tends, such as Standard Life’s Ed Legget and SVM’s Margaret Lawson, tend to do better when markets rally.

Performance of funds over 7yrs

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Source: FE Analytics

Tim Cockerill, investment director at Rowan Dartington, agrees. He says that investors often make the mistake of selling out of a fund when the market moves in its favour, highlighting FE Alpha Manager Woodford as someone who has proven his doubters wrong time and time again.

“You know what Neil Woodford is about, and know that during a roaring bull market he’s going to underperform,” he said.


“As long as you know that, it’s fine. If you are running a balanced portfolio, you don’t want all your funds to race away together.”

FE data shows that Woodford has underperformed his peer group composite in the calendar years of 2009, 2010 and 2012 – all strong years for risk assets.

However, in the years that markets have struggled – namely 2007, 2008 and 2011 – he has significantly outperformed. This has translated into strong outperformance over the past seven years, as the graph below shows.

Performance of manager and peers over 7yrs

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Source: FE Analytics

“The problem comes when a fund that you expect to fly with the market doesn’t, and vice versa. At that point, you need to understand why that’s happened.”

“It may be that you misunderstood the process, that the process wasn’t as robust as you thought it was, or that that the manager isn’t as good as you thought.”

In these cases, Cockerill says investors should probably take the decision to look elsewhere.

In recent years he points to Jupiter Absolute Return as one that failed to perform in the way he expected. Former manager Philip Gibbs was famed for making money while running a financials fund in 2008, but his absolute return vehicle lost money in 2011. Between its launch in late 2009 and his exit in August 2013, it failed to keep up with inflation.

Performance of fund Dec 2009 – Aug 2008


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Source: FE Analytics


James Clunie took Gibbs’ place, and has made a decent start, returning just over 2 per cent to investors.

Head of research at Hargreaves Lansdown Mark Dampier says that the performance of the absolute return fund under Gibbs was “one of the biggest disappointments of my career.”

“The problem was that he was so bearish that he didn’t really do anything – he was just stuck on the sidelines,” said Dampier.

Ben Willis, head of research at Whitechurch Securities, says he sold out of the JPM Strategic Bond fund because it didn’t hold up as well as he expected during the May and June last year.

Performance of fund and sector in 2013

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Source: FE Analytics

FE Alpha Manager David Coombs, head of Rathbones' multi-asset range, highlights Tom Dobell’s £6.9bn M&G Recovery fund as one that has disappointed of late.

The fund has traditionally had a strong record in rising markets, but fell well short of its sector and benchmark in the up years of 2012 and 2013.

Coombs believes that mass inflows, which pushed assets under management (AUM) to as high as £8bn in 2012, has played a part in the recent underperformance, as it has limited his ability to invest in small and mid-cap stocks.

However, Cockerill says he is sticking by Dobell. While other recovery funds such as Schroder Recovery have performed very well in recent years, he believes that Dobell’s style lends itself to a longer holding period than three years.

“This is a case of two funds being called the same thing but doing something very different,” he said.


Performance of fund, sector and index over 3yrs

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Source: FE Analytics

“I think the performance has a very good chance of reversing in the future. I like Dobell very much as a stockpicker – this good be the right time to buy, if anything.”

The onset of M&A and the improving outlook for commodities could be drivers of performance, Cockerill adds.

Daniel Lockyer, manager of the PFS Hawksmoor Distribution fund, is also a fan of M&G Recovery, and believes that Dobell’s style will inevitably come back into favour before long.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.