Most investors will look back at a fund’s past performance when judging a manager’s ability and pedigree, despite the Financial Conduct Authority and the asset management world’s efforts to stop them concentrating on this.Ashworth-Lord says it is inevitable that investors will look at a fund’s track record.
But he points out that various factors mean its unit holders may have had a very different experiences even if it delivered stellar returns over some time frames.
“Peter Lynch managed the Fidelity Magellan Fund from 1977 to 1990, during which time it beat the S&P 500 Index in 11 years and achieved an average return of 29 per cent per annum.
You might therefore think that most of his investors would have made money,” Ashworth-Lord (pictured) said.
“But guess what? Lynch said that he believed more than half the unit holders in his fund had actually lost money.”
“It all depended on when they had bought and sold Magellan units. Researchers estimated that the average Magellan investor earned a return of 13.4 per cent per annum from 1981 to 1990, trailing both the fund and the S&P 500's 16.2 per cent return.”
He added: “How does the typical investor in a fund run by one of the most successful managers of all time end up falling behind the overall market? The reason is simple: poor timing.”
The manager says this experience isn’t confined to investors in Lynch’s Magellan fund, as a study in the US tracking fund flow data showed that between 1989 and 1994, active funds delivered an annual compounded return of 12.5 per cent, while actual investors lost 2.2 per cent a year.
Ashworth-Lord says this shows that a large proportion of investors are very poor at trying to time the market.
The reason for that, according to the manager, is most investors are impatient and will tend to chop and change their portfolios in an overly-active manner.
“When a fund has a great year, it gets onto everybody's radar and attracts more investors. A hot fund's assets might triple the year after,” the manager said.
“The new money has to be invested and this might become a drag on performance for a short while until the new investments get into their stride. Meanwhile, the average investor loses patience and sells to go chasing the newest hot idea.”
“Lynch described this in an interview. One Saturday, early on in his tenure, he was working at the office and answered the phone. The caller was a Magellan holder who was calling to cash in the investment. Lynch explained how he was excited about the growth prospects for the economy and his fund, and asked him why.”
“The caller said: ‘Because I am breaking even.’ Magellan then went on to record compounded annual growth of around 20 per cent for a decade during the 1980s.”
There have been a number of examples in recent years of investors chasing returns from funds that have already performed very well; one of which is multi-cap income funds.
After small and mid-caps were so badly hit during the financial crises in 2007 and 2008, they have driven the UK equity market over the past five years due to their low valuations and because they have benefitted from the recovering economy and increased appetite for risk.
According to FE Analytics, PFS Chelverton UK Equity Income, Marlborough Multi Cap Income and Unicorn UK Income – which all have a smaller company bias – have topped the IMA UK Equity Income sector over three years due to their stellar returns in the rising market of 2012 and 2013.
Performance of funds vs sector and index over 3yrs
Source: FE Analytics
Data from FE Analytics shows that three have been among the best-selling funds in the sector over the last year.
Unicorn UK Income has grown from £350m to £607m over 12 months, Marlborough Multi-Cap Income from £470m to £960m and PFS Chelverton from £150m to £340m.
While all three funds outperformed in the final few months of 2013, the large majority of those assets poured in at the start of 2014 and, due to the sell-off in mid and small-caps, they have all lost money year to date, underperforming against the sector and index as a result.
Performance of funds vs sector and index in 2014
Source: FE Analytics
The manager says another reason why investors don’t receive the return a fund delivers is due to “recency bias”.
By this, Ashworth-Lord says that, more often than not, investors will tend to prepare their portfolios for the last thing that happened rather than what is going to happen next.
“In 1987, I was working in a stockbroker’s office. The day after the market crashed on Black Monday, people began to worry that the market was going to crash further,” the manager said.
“Those investors who got out on the Tuesday so they wouldn’t be fooled again as they just had been on the Monday, actually were fooled again as the market went back up. We see the same behaviour in corrections like the minor one we have been going through recently.”
“As Lynch said: ‘Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.’”
Ashworth-Lord says this all points to the conclusion that investors need to take a long-term view on equities.
“If you are an investor, you have to accept that there are going to be declines. And every couple of years or so, you are going to get a 10 per cent correction. If you can’t stomach that, you should not be in the stock market. Then there is your timing. Is your time horizon one year?”
“If so, you are just gambling on red or black at the casino. Time is on your side in the stock market. When stocks go down, if you've got the money, you don't worry about it and you put more in.”
Ashworth-Lord launched his five crown-rated Premier ConBrio Sandford Deland UK Buffettology fund in March 2011 which, as it name suggests, follows the principles of legendary investor Warren Buffett.
According to FE Analytics, the £20m fund has been a top quartile performer in the IMA UK All Companies sector over that time with returns of 56.23 per cent.
As a point of comparison, the FTSE All Share has returned around half that amount.
Performance of fund vs sector and index since March 2011
Source: FE Analytics
The fund has an ongoing charges figure (OCF) of 1.94 per cent, but that is expected to fall over the coming years as it attracts more assets.
As a follow-up from Ashworth-Lord’s comments later this week, FE Trustnet will look at some of the top-performing and most popular IMA funds and by using FE fund flow data, see how the majority of investors have actually performed.
