Hour upon hour of research goes into finding the very best funds in a sector while flagging up those that look as though they should be avoided at all costs. But while it’s quite easy to see how a given fund has performed on its own, what’s more difficult is finding out how its inclusion in a portfolio would have affected the overall outcome for the investor.
In an article kicking off a new series, we recently looked at what would have happened if there was an additional 10 per cent exposure to gold in a balanced portfolio. In this article, we thought it would be interesting to see how the portfolio would have behaved if some of the UK’s best and worst performing funds were added to it. 
In order to find out the effect that winners would have had on a balanced multi-asset portfolio and compare it to the outcome experienced by those that were holding some of the period’s weakest funds, we started with the Wealth Management Association’s balanced portfolio (current asset allocation on the right).
To this, we added a 10 per cent allocation to a composite portfolio of the five funds with the best scores in our recent study that ranked funds on their performance for performance and risk metrics such as cumulative five-year returns up to the end of 2015 as well as the annual returns of 2015, 2014 and 2013, annualised volatility, maximum drawdown, downside capture, alpha generation, Sharpe ratio and upside capture.
The funds that went into this portfolio were CF Lindsell Train UK Equity, Neptune UK Mid Cap, Royal London Sustainable Leaders Trust, Invesco Perpetual UK Strategic Income and EdenTree UK Equity Growth.
For the portfolio with the weakest performers we added a 10 per cent allocation to Scottish Widows UK Select Growth, Halifax Special Situations, IFSL Trade Union Unit Trust, Dimensional UK Value and M&G Recovery, which came bottom in that study.
Performance of portfolios vs index over 5yrs
Source: FE Analytics
As the above graph makes clear, the performance profiles of these two sub-profiles could not be more different. While the top performers made a 96.82 per cent total return over the past five years, the portfolio of the worst performers failed to break the 10 per cent mark; the balanced portfolio sat in between the two.
In addition, given that the outperforming portfolio was built of funds that were at the top of their peer group for metrics such as maximum drawdown, Sharpe ratio and annualised, it’s no surprise to see it beating the underperforming funds when it comes to these measures as well – although the balanced multi-asset portfolio has done between than both, given its more diversified nature.
Source: FE Analytics
But what happens when these funds are introduced into the balanced portfolio?
As can be seen, a 10 per cent allocation to the best performers does result in a boost to returns while the portfolio with the poor performers falls behind. Over five years, the balanced portfolio with the successful fund makes 10 percentage points more than one with the underperformers.
What should be kept in mind at this point is that the two ‘new’ portfolios have a higher allocation to UK equities than the Wealth Management Association’s balanced portfolio, which skews their results relative to it by a slight margin.
Performance of portfolios over 5yrs
Source: FE Analytics
Looking at other metrics also shows some changes. Both of the portfolios with extra funds have been more volatile than the balanced allocation, but this is only to be expected given that they contain a higher proportion of equities; the same is true of other metrics like maximum drawdown.
But including the sector-topping funds has resulted in a much higher Sharpe ratio, showing that the managers have achieved their returns without loading up on too much unnecessary risk.
One that does jump out is that the portfolio with the outperformers has the fewest positive months of the three.
However, it seems that during the down times these managers managed to protect capital more efficient (shown by the lower maximum drawdown) and make more money in rising markets (suggested by the maximum gain) than the underperforming funds.
None of the above should be too surprising – in essence, it shows that if you out some funds with great track records in a portfolio and look back, then all the past performance looks better than if you put a group of poorly performing funds in there.
In fact, the take-home point of this article may well be another way of highlighting the importance of building a properly diversified portfolio.
Performance of portfolios over five years
Source: FE Analytics
Holding the funds alongside international equites, fixed income, property, alternatives and cash might have led to lower returns than just the outperforming equity funds alone but it significantly moderates the weak returns from the lagging funds.
Looking over the tables in this article, there’s also an improvement in volatility and maximum drawdown suggesting that a ‘better’ investment journey than active equity alone would have offered.
