FE Trustnet has, on many occasions, highlighted the potential pitfalls of buying top-performing funds that have seen their assets under management (AUM) surge on the back of strong inflows.
That being said, experts tend to agree that just because a fund is large it doesn’t mean it will start to underperform.
Nevertheless, those who say size does impact on performance liken giant funds to cruise liners. The idea here is that even the most experienced of skippers will struggle to manoeuvre a giant vessel as easily as they would a 40-foot yacht.
With that in mind – and in the next article of the series – we ask some of our regular contacts which funds they think are currently at a manageable size, but could be hit with capacity constraints in the not-too-distant future if inflows continue at their current rate.
While investors shouldn’t necessarily sell these funds, the experts say they should keep a close eye on their AUMs over the coming years.
Old Mutual Global Equity Absolute Return
Chris Metcalfe, investment director at IBOSS, has told FE Trustnet numerous times that he and his team tend to avoid large funds, stating that backing a multi-billion fund is just another risk that he feels he doesn’t need to take.
In the first of these two articles, Metcalfe said he felt that none of the funds within his portfolios were too big, though he highlighted the five crown-rated TwentyFour Dynamic Bond fund as one he was slightly concerned about.
He says the only other one he is worried about is the five crown-rated Old Mutual Global Equity Absolute Return, which has swelled to £1.5bn.
Metcalfe is a big fan of the fund and its management team of Ian Heslop, Mike Servent and Amadeo Alentorn, using it across for his cautious, balanced and aggressive portfolios. However, if inflows carry on at their current rate, he says he will begin to review his exposure.
It isn’t too difficult to see why the fund – which sits in the IMA Targeted Absolute Return sector – has attracted so much investor attention, though.
Performance of fund vs sector since June 2009
Source: FE Analytics
According to FE Analytics, it has returned 40.08 per cent since its launch in June 2009.
While that is only half the gain of the IMA Global sector average, it has been three times less volatile and its maximum drawdown – which measures how much an investor would have lost if they bought and sold at the worst possible time – has been three times lower over the period.
The managers’ stock-picking skills, along with their ability to go long and short, mean the fund returned 11 per cent in 2011 when the Global sector fell 10 per cent.
While Metcalfe says he is concerned about the growing size of the fund, he applauds the group for alerting unitholders that Heslop, Alentorn and Servant are fully aware of future possible capacity constraints and are therefore willing to close the strategy if size does begin to affect their management of the portfolio.
A spokesperson from Old Mutual Global Investors reiterated this point by saying that while the fund remains open, it will look to close the fund at around $3bn (£1.9bn).
Aberdeen Global High Yield Bond
With interest rates at such low levels and traditional safe haven bonds like gilts and US treasuries yielding very little, investors have been upping their exposure to lower quality bonds to boost their income.
Ben Willis, head of research at Whitechurch, understands why high yield bonds are becoming more and more popular. However, with valuations at historically high levels and as liquidity is diminishing within the corporate bond market, he says investors need to be very careful about which fund they choose.
Though Willis didn’t name any names, he says investors should be wary of high yield bond funds which are larger than £1bn.
One that fits into this category is the £1.5bn Aberdeen Global High Yield Bond fund, which yields 5 per cent and is managed by Steven Logan and Kevin Mathews, as it is the largest UK-domiciled fund in the IMA Sterling High Yield sector.
The fund, which has narrowly beaten the sector over five years but has underperformed over one and three years, has actually seen outflows over the last year, however.
Performance of fund vs sector over 5yrs
Source: FE Analytics
A spokesperson from Aberdeen told FE Trustnet that while the size of the fund is continually monitored, the managers don’t foresee any real capacity constraints for the time being.
“The size of a fund is always and quite rightly a valid area to look at, but not in isolation,” the spokesperson said.
“The [Aberdeen Global High Yield Bond] fund is very well diversified by number of investments – around 400 – and is global in nature with 80 per cent in US dollar bonds and 20 per cent in European high yield with scope to invest in emerging markets too. This provides it with more levers to pull in terms of access to liquidity.”
The spokesperson also pointed out that the five largest high yield ETFs in the US average $7.5bn in size and therefore the fund is relatively small versus much of the competition.
R&M UK Equity Smaller Companies
Another area that Willis says investors need to be wary of potential capacity constraints is within the UK smaller companies space.
Again, he didn’t name any names, but he says – as a general rule – he keeps a close eye on funds in the IMA UK Smaller Companies sector which have an AUM approaching £500m or above.
His point is that at a certain stage, if a manager has to deal with inflows, they either have to avoid the smallest companies or increase their number of holdings – either way, they have to change the way in which they run their portfolios.
There are a number of portfolios in the sector which fit into that category such as the £1.2bn Standard Life UK Smaller Companies fund, the £852m Marlborough Special Situations fund and the £810m Old Mutual UK Smaller Companies fund.
One fund which could be joining those ranks, if inflows continue at their current rate, is the £420m R&M UK Equity Smaller Companies fund which has been the sector’s bestselling fund over the last year after attracting £350m.
Again, it isn’t difficult to see why it has become so popular.
Performance of fund vs sector and index over 3yrs
Source: FE Analytics
It was the best performing portfolio in the sector in 2012 and 2013 with returns of 36.98 per cent and 59.62 per cent respectively. On top of that, it is top quartile performer so far in 2014 with returns of 1.06 per cent while the sector and its benchmark are both down more than 4 per cent.
It is also now run by FE Alpha Manager Philip Rodrigs, who generated very strong outperformance relative to the wider market as manager of the Investec UK Smaller Companies fund.
A spokesperson from R&M said that the past performance, the team’s PVT (Potential, Value and Timing) approach and the hiring of Rodrigs and Daniel Hanbury before him – who also joined from Investec – are the major reasons for the inflows.
However, the spokesperson said the group would look to hard-close the fund at £750m so that Rodrigs can continue to buy companies with a market cap of less than £100m.
The spokesperson also said Rodrigs and his team are firm believers that beyond the £750m mark, size would start to dilute their ability to generate alpha.
