It’s natural for investors to want top-quartile funds when looking to refresh their portfolios. 
However, in an article published last week, Sarasin & Partner’s Lucy Walker told FE Trustnet that investors should actually avoid top-quartile funds and instead search for value opportunities in the bottom quartile.
“My biggest piece of advice would be to stay away from the funds in the top charts. I think the most important thing for investors to think about is that investment is cyclical and markets are cyclical. Japan will go in and out of favour, India will go in and out of favour, equities will go in and out of favour, and that’s a much bigger force than any one fund manager can contend with,” she said.
While Darius McDermott (pictured), managing director of Chelsea Financial Services, doesn’t necessarily agree that buying fourth-quartile funds is always the best bet, he does believe that it’s important not to sell a fund straight away if it endures a period of underperformance.
“We don’t subscribe to the theory of only buying into fourth-quartile funds but, on our rated panel, there are always going to be one or two of them undergoing difficult periods – I think it’s more a matter of why they have done badly and whether or not you share the manager’s view,” he said.
“It may be that they’re overweight mining, for example. Mining’s been terrible and if you’re buying a contrarian investor, they’re often going to be buying things that are struggling.”
“I’d want to know why they’ve done so poorly and see whether the view they’re implementing is consistent with the views that we want our funds to be showing.”
With this in mind, McDermott tells FE Trustnet the funds that he particularly likes, yet have undergone a 12-month period of significant underperformance.
Over the last year, L&G UK Alpha has underperformed both its peer average in the IA UK All Companies sector and its FTSE All Share benchmark, returning just 0.55 per cent.
Performance of fund vs sector and benchmark over 1yr
Source: FE Analytics
This is unsurprising, seeing as the £190m fund struggled in 2014 and lost 0.86 per cent over the year. While its peer group and benchmark didn’t fare much better, returning 0.64 and 1.18 per cent respectively, it seems that L&G UK Alpha is yet to improve on last year’s performance.
Despite this, the fund, which has been managed by Richard Penny since 2005, has achieved stellar performances over the long term, providing a return of 229.4 per cent since launch and comfortably doubling the returns of its sector and average peer.
“A big chunk of this fund is in small companies. Penny either buys smaller companies with a lot of growth potential or he buys contrarian value – he has two buckets that he invests in,” McDermott explained.
“Historically, his performance generally is volatile. But, over the long term has he produced substantial returns although if I was looking at funds to add to, I personally wouldn’t right now, seeing as it has done badly over the last year.”
Over the last three, five and 10 years, the fund has found itself in the bottom quartile for annualised volatility and bottom quintile for max drawdown, which measures the worst possible peak-to-trough return at any one point.
However, volatility is to be expected from a fund that holds almost a third of its portfolio in companies that are between just £50m and £250m in size.
L&G UK Alpha has a clean ongoing charges figure (OCF) of 0.78 per cent.
Managed by Matthew Vaight and deputy-managed by Alice de Charmoy, M&G Global Emerging Markets is another fund that hasn’t impressed with its performance over the past year, having lost 12.5 per cent.
Performance of fund vs sector and benchmark over 1yr
Source: FE Analytics
However, emerging markets have understandably had a tough time of late as a result of China’s plummeting stock market, the recession in Russia, slow reform progress in India and political scandals in Brazil.
“It’s a fund that we rate, although it is at the very bottom of the fourth quartile,” McDermott said.
“Again, Vaight is a contrarian value manager – I know a portion of that performance is down to having invested in Russia. But I still think he is a very good manager and he’s just a manager that has had a bad year. All managers have bad years.”
In terms of regional weightings, the £1.5bn fund is actually underweight Russia, Taiwan, China and India, yet still holds weightings in each.
M&G Global Emerging Markets is also overweight Brazil and holds 10.4 per cent in the region, which is 2.8 percentage points more than its MSCI Emerging Markets benchmark.
In terms of stocks, the fund’s largest holdings are Samsung Electronics at 4.88 per cent, Taiwan Semiconductor Company at 3.8 per cent, Chinese insurance company PICC Property and Casualty at 2.86 per cent and Brazilian drinks company Companhia de Bebidas das Americas at 2.82 per cent.
M&G Global Emerging Markets has a clean OCF of 1 per cent and yields 1.68 per cent.
Bond funds have dwindled in popularity recently as investors eye the likely interest rate hike in the US and fret about the impact this could have on fixed income portfolios.
Jupiter Strategic Bond, managed by FE Alpha Manager Ariel Bezalel, is no exception and has fared particularly badly over the last year, returning just 1.59 per cent and slipping into the third quartile.
Performance of fund vs sector and benchmark over 1yr
Source: FE Analytics
McDermott said: “Ariel is a very good fund manager with a long-term track record. I think if I was adding to bond funds it would be a fund I would consider.”
“I’m not exactly sure why he’s done badly this year. The average fund has returned 2.79 per cent [over 12 months] so it’s not a huge underperformance, but still far from brilliant in terms of sector average.”
Despite its recent dip in performance, the £2.6bn fund has outperformed its benchmark and peer average over three and five years.
Jupiter Strategic Bond has also made its way onto the FE Research Select 100 list due to Bezalel’s strong track record and the fact that the AFI panel of leading financial advisers hold the fund in high regard.
Not only this, the FE Research team particularly likes the fact that the fund isn’t constrained by any benchmark and can invest in a wide range of bonds, which means he has greater freedom to adapt his portfolio depending on the economic climate.
“Bezalel has taken full advantage of his unconstrained mandate. By varying the portfolio’s allocation to government bonds or high- or low-rated corporate bonds according to his assessment of the economy, he has generated outstanding performance since the fund’s inception,” the team said.
Since the fund’s launch in 2008, it has returned 87.98 per cent, almost doubling the performance of its sector average.
Jupiter Strategic Bond has a clean OCF of 0.73 per cent and yields 5.1 per cent.
