Over the last few weeks, various financial experts have told FE Trustnet of the potential pitfalls of only looking to invest in top-quartile funds.
The topic of debate was originally sparked by Sarasin & Partner’s Lucy Walker, who said that her value-based investment approach often leads to her turning to the fourth quartile in search of attractive investment opportunities.
“My biggest piece of advice would be to stay away from the funds in the top charts,” she said last month.
“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.” 
Martin Bamford (pictured), chartered financial planner and managing director at Informed Choice, also encourages investors not to judge funds based solely on past performance, as there are plenty of funds worth picking which are not necessarily top quartile performers in each timescale.
As such, he tells FE Trustnet his three favourite bottom-quartile funds that are worth holding onto
M&G Recovery
M&G Recovery has featured in a number of FE Trustnet articles recently and was also chosen by S&G Wealth Management’s Neil Shillito last week as one of his bottom-quartile fund picks.
The fund has been popular among investors over manager Tom Dobell’s 15-year tenure and has drastically outperformed both its peer average in the IA UK All Companies sector and its FTSE All Share benchmark, providing a total return of 140.18 per cent.
Performance of fund vs sector and benchmark over manager tenure
Source: FE Analytics
However, the fund has fallen from grace over the last one, three and five years, landing in the bottom decile over each of these time frames.
As reported by FE Trustnet earlier this month, M&G was also named the biggest ‘dog’ fund in its sector by Tilney Bestinvest.
“The main reason for such abysmal performance in recent years appears to be the long-term nature of the fund, holding onto stocks which have fared badly in the short term – for example its largest position, BP. Investors who are prepared to take the long-term view of returns, as all investors should, could do well by holding onto this fund,” Bamford said.
Since the Deepwater Horizon oil spill in 2010, BP, which accounts for 6.68 per cent of the fund’s portfolio, has struggled to revive its performance and has made a loss of 28.25 per cent.
Some investors have pointed out that the fund’s large size could have also been a reason behind its underperformance. While the fund is a hefty size at the moment, it has in fact shrank by more than 42 per cent over the last three years, having boasted an AUM of £7.6bn at the start of the period.
M&G Recovery has a clean ongoing charges figure (OCF) of 0.91 per cent.
Co-managed by Dhiren Shah and Luiz Soares since 2011 and 2012 respectively, this three FE Crown-rated fund has been in the third quartile over one and three years and has slipped into the fourth quartile over the last six months.
The fund has also failed to outperform its sector average and its MSCI Emerging benchmark over Shah’s tenure.
Performance of fund vs sector and benchmark over management tenure
Source: FE Analytics
Despite this, Bamford and the team at Informed Choice continue to actively recommend the fund for client portfolios.
“Within the IA Global Emerging Markets sector, where this fund sits, there is relatively little in it between an above or below sector average fund,” he pointed out.
“Over the past year, for example, this fund has returned -11.82 per cent compared to a sector average of -11.11 per cent. This 71 basis point difference is enough to push the fund into the bottom quartile, but in relative performance terms is not particularly stark.”
“To date this year, the fund has suffered a sharp drawdown, due mainly to stock selection, followed by some significant outperformance at the end of the first half. This highlights the importance of not judging funds solely on relative performance alone, but understanding the various factors causing different periods of fund performance.”
Currently, BlackRock Emerging Markets has a 57.65 per cent weighting in the Pacific Basin, 16.14 per cent in the Americas, 9.35 per cent in Asia Pacific and 6.29 per cent in Europe excluding the UK.
In terms of stocks, the fund holds the Bank of China, Japanese trading company Itochu Corporation and Taiwan Semiconductor Manufacturing as its top three holdings.
BlackRock Emerging Markets has a clean OCF of 0.96 per cent.
Royal London UK Government Bond
Government bonds are likely to turn even the most bullish investor pale at the moment in light of the impending interest rate rise, but Bamford says investors should continue to have some exposure to gilts for diversification purposes.
Royal London UK Government Bond, managed by Paul Rayner and Craig Inches, is a bond fund that he particularly likes despite its bottom-quartile performance over one and three years.
Over three years, the fund more than halved the performance of its benchmark, returning just 4.6 per cent.
Performance of fund vs benchmark and sector over 3yrs
Source: FE Analytics
“This another fund with a long-term investment objective, aiming for a combination of income and capital growth over five to seven years,” Bamford explained.
“The fund has the very experienced management team of Craig Inches and Paul Rayner, and a high exposure to conventional gilts, with some deviation from the FTSE All Stocks Gilts index.”
Inches and Rayner believe that, because bond markets are not always efficient, active investors can use these inefficiencies to their advantage and outperform the benchmark.
They adopt an initial top-down evaluation of the markets, then RLAM’s economist, Ian Kernohan, forms the basis for interest rate, inflation and short, medium and long range yield forecasts.
The fund has been awarded a Square Mile rating of ‘A’, as its research team particularly likes the managers’ process of combining macroeconomic factors with an understanding of the UK bond market.
“This fund may be suitable for investors who are seeking to obtain a secure source of income, but who are willing to tolerate some level of volatility in the short to medium term. The current level of income is low reflecting the prevailing interest rate environment,” the team said.
Royal London UK Government Bond has a clean OCF of 0.44 and yields 1.39 per cent.
