Metcalfe (pictured), an investment director who also runs fund of funds portfolios, has moved clients’ money out of a number of the best-known and best-performing funds in recent years because of worries over capacity, including Julie Dean’s former Schroder UK Opportunities fund.He says any indication that a manager has to change their style because of the rate of inflows should send the alarm bells ringing – especially if stemming flows or soft-closure is mentioned.
“Any sign of a disturbance at all we see as a warning sign. If we hear anything it certainly makes us review our position. It suggests to us that the manager isn't comfortable,” he said.
His comments come in light of the recent underperformance of Schroder UK Opps, which has had a terrible period of performance in 2014. The fund hasn’t been marketed for some time due to concerns over capacity, but has remained open on all major platforms nonetheless.
Metcalfe points out that retail money still tends to flow into funds even when concerns over capacity are voiced.
When funds top the sales charts month after month, he says this confirms it’s probably best to take profits and look elsewhere.
"Retail money was still very much pouring in [to Schroder UK Opps even though it wasn’t marketed],” he said.
“You'd have to say that retail investors are not as informed as professionals. They don't have the same access to the managers, but see a very good fund with a good track record. The problem is of course that often they invest at exactly the wrong time, as it's turned out in this case."
Performance of funds and sector in 2014
Source: FE Analytics
"It's when the fund tops the sales tables when it's time to get worried. When you see these funds being promoted by IFAs all over the place, it's a warning sign."
"These aren't things you can put on a quant screen, but you have to do the work."
As well as Schroder UK Opps, Metcalfe has sold out of M&G Global Dividend, Newton Asian Income, BlackRock UK Special Situations and M&G Recovery due to concerns over capacity over the past 18 months. All have underperformed their benchmarks in 2014.
He’s keeping an eye on Henderson UK Property as well but is still a holder. It has almost doubled in size to £2.4bn in the last 12 months.
Richards (pictured), manager of the £35m Thesis Optima Balanced portfolio, doesn’t think fast-growing funds will always underperform, but says that the “balance of probabilities” means investors are better off looking elsewhere.
While some view news of a soft-closure as a reason to get into a fund quickly in order to avoid extra charges, Richards says he often sees it as a sign he should sell.“Funds groups do of course soft close their funds and we sometimes take this as an early warning sign – it’s a self-admission of problems, although they will tell you it’s in investors future interests,” he said.
“We’ve seen a number of funds soft-close and then underperform for periods thereafter. Ironically, some of these have then reopened again as they’ve gone and lost investors through their periods of underperformance and capacity has opened up again. This only adds to my cynicism,” he added.
Among the funds that have soft-closed in recent years are the likes of Aberdeen Emerging Markets Equity, First State Global Emerging Markets Leaders, Standard Life UK Smaller Companies, Fidelity UK Smaller Companies, GLG Japan CoreAlpha and Schroder UK Dynamic Smaller Companies.
Harry Nimmo’s £1.2bn Standard Life fund, Clive Beagles’ JOHCM UK Equity Income fund and Stephen Harker’s £1.3bn GLG Japan Core Alpha fund have all re-opened after initially soft-closing.
Alex Brandreth, a portfolio manager at Brown Shipley, believes underperformance following soft-closures often occurs because model portfolios are forced to sell their stakes, making life difficult for managers.
“Funds can only be a ‘buy’ or ‘sell’ for model portfolios, but not a ‘hold.’ If a fund manager receives new money, a fund with an initial fee is no longer appropriate,” he explained.
“Interestingly, we’ve noticed a number of funds close and then reopen shortly after as AUM falls. It is interesting to watch the performance over this period because when a fund manager is a forced seller, it’s a different mind-set to that which they are used to.”
Richards is currently reviewing his exposure to Jason Pidcock’s £4.7bn Newton Asian Income fund due to concerns over fund size, even though the manager is yet to voice any concerns personally.
"We've been looking at it for a long while because of the inflows. It's suffered some stock specific issues – one listed in New Zealand for example – and perhaps the size contributed to these. It's certainly on our watch list,” he said.
Richard Woolnough recently admitted that he’s finding it more difficult to add value through stockpicking in his £23bn M&G Optimal Income portfolio.
Richards says he took this as a reason to sell, though acknowledges that so far this decision is yet to pay off as the fund has continued to perform strongly.
Performance of fund and sector over 3yrs
Source: FE Analytics
“Personally, I have the most respect though for groups and managers who simply ‘hard close’ and manage what they’ve got, [even though] I realise that doesn’t suit us as the fund buyer, as we need to keep continuity of investment to accommodate the new business we sign up,” Richards added.
Metcalfe is more scathing of fund groups that keep their products open for too long.
He specifically asks managers how their remuneration is broken down before investing, in order to avoid those incentivised by “asset gathering”.
"It seems to us that it’s in the interests of the fund houses to sweep the issue under the carpet,” he said.
“There's no escaping it – there’s a lot of hoovering-up of asset.”
"We target managers who are not paid on land grabs, but on performance. It's a question we always ask and it’s off the record. Unfortunately it's like asking someone's age – not everyone likes to answer."
"It was very refreshing being in a meeting with Paul Smith from Premier recently. At the end of the meeting he said that it made no difference to him if we invested because he gets paid on getting top quartile performance. We love that."
