We recently examined the unexpected exposures that could emerge if investors were to buy five of the most popular funds at the moment, discovering that they would be heavily exposed to the UK and have very little in areas perceived to offer better value such as Japan, Europe and emerging markets.
While we conceded that such behaviour would be the action of a “hypothetical lazy” fund buyer, investors have displayed a tendency to move into portfolios that have just had a strong run of performance and have proven popular with others.
Ben Willis (pictured), head of research at Whitechurch Securities, told FE Trustnet: “History shows that people tend to buy the funds that have performed well or proven most popular, because there is sometimes a herd mentality and a perception of safety in numbers.
But this means you tend to buy at the wrong time – after they’ve had a great run.”To discover how well our hypothetical herd investor has done over recent years, we built an equally weighted portfolio of six of the most popular funds three years ago and looked at how well they performed against various benchmarks.
The research found that while the portfolio did well in the three years before the investor bought, it failed to achieve the same results over the following three years.
A host of familiar names were popular in the third quarter of 2011 - including Iain Stewart's Newton Real Return, Stuart Rhodes' M&G Global Dividend and Paul Causer, Paul Read and, at the time, Neil Woodford's Invesco Perpetual Monthly Income Plus funds.
The other funds benefiting from strong inflows were Gary Potter and Rob Burdett’s F&C MM Navigator Distribution (then named Thames River Distribution), Richard Woolnough’s M&G Optimal Income and Nigel Thomas’ AXA Framlington UK Select Opportunities.
During 2011’s third quarter, fund sales tables showed that strategic bond and cautious managed funds were persistent favourites, as investors wrestled with issues such as the downgrading of the US’ AAA credit rating and fears of contagion from the eurozone debt crisis.
In pure performance terms, it’s easy to see why these six funds were popular during this period as each one of them had returned more than double the gains of the FTSE All Share and the MSCI AC World indices over three years.
Meanwhile all beat corporate bonds represented by the iBoxx Sterling Corporate All Maturities index except for Thames River Distribution.
Performance of portfolio vs indices between Aug 2008 and 2011
Source: FE Analytics
The portfolio returned 24.06 per cent between 27 August 2008 and 26 August 2011.
This compares with the 5.64 per cent rise in the FTSE All Share, the 7.80 per cent gain in the MSCI AC World index and the 18.79 per cent return from the iBoxx Sterling Corporate All Maturities index.
M&G Optimal Income made its investors the most money over time, rising 37.24 per cent, and was the third best performing in the 48-strong IMA Sterling Strategic Bond sector over the period in question.
Invesco Perpetual Monthly Income Plus was the second best performer in the portfolio, with a 24.44 per cent gain.
It was ranked eleventh out of its strategic bond peers at the time.
Fast forward to today and the portfolio has not fared as well as the MSCI AC World or the FTSE All Share, after developed stock market rallied strongly while investors began to call the end of the 30-year bull market in bonds.
While the MSCI AC World gained 51.64 per cent in the three years to 26 August 2014 and the FTSE All Share rose 52.14 per cent, our herd investor’s returned just 38.14 per cent.
This is no doubt due to four of its members coming from the strategic bond, absolute return or former cautious managed sectors.
Performance of portfolio vs indices between Aug 2011 and 2014
Source: FE Analytics
The herd portfolio currently has 34.44 per cent in global fixed income, with another 5.78 in UK bonds.
Its UK equities exposure stands at 28.22 per cent while 13.58 per cent is in North American stocks and 7.55 per cent in European companies.
Only two funds managed to beat the MSCI AC World and the FTSE All Share over the past three years - AXA Framlington UK Select Opportunities and M&G Global Dividend.
Thomas’ UK fund has returned 60.17 per cent while Rhodes’ global portfolio is up 52.65 per cent.
It is worth noting that these funds appeared to be less popular three years ago than offerings from the strategic bond or cautious managed sectors.
So while they have managed to comfortably outpace the market since, the herd-following investor is likely to have put less into these funds.
The portfolio has easily beaten corporate bonds, however, with its 38.17 per cent rise being significantly ahead of the iBoxx Sterling Corporate All Maturities’ 28.77 per cent.
Five of its constituent funds outperformed the index but Newton Real Return was up just 15.80 per cent over the period.
Looking at other measures over the most recent three years, the herd portfolio’s volatility at 16.98 per cent is significantly less than the FTSE All Share’s 13.18 and the MSCI AC World’s 12.13, given its constituents’ defensive tilt.
It is only slightly higher than the corporate bond index’s, which was 4.76 per cent for the three-year period.
It also has a lower maximum drawdown than all three benchmarks, at 5.16 per cent.
The corporate bond index has a three-year maximum drawdown of 5.94 per cent, while both the equity indices are over 10 per cent.
The latest figures from the IMA shows UK equity income, property and strategic bond funds were the most popular with investors at the start of 2014’s third quarter.
In coming articles, we will examine the lesser known funds in these sectors that might be worth keeping an eye on.
