Funds of funds are generally considered to be a long-term investment and are particularly popular with pension investors who want to outsource fund selection to a professional.
However Dampier, head of research at the firm, says that the pressure to outperform over the short-term means that investors’ interests are not aligned with managers’, which often leads to disappointment in the long-run.
He says that fund of funds managers who constantly chop and change their portfolio more often than not take value away from their benchmark.
"They’re just not long-term enough – they change around their portfolio too much," he said. "I can remember talking to Neil Woodford some time ago and he asked me: 'Why is a fund manager putting £50m in to my fund and taking it out three months later?' I’d have to agree with him."
"Why would you put that money in to a manager who’s so long-term in his approach, just to take it out again? I think a lot of things come in and out of fashion very quickly, and managers react to that."
"I think people sometimes try to be too clever. Often it’s because the manager chops and changes their asset allocation, but this is very difficult. We added Europe last year because it was two standard deviations cheaper than its historical average, but usually valuations are in no-man’s land."
"Everyone goes on about how asset allocation adds loads of value, but from my experience more often than not it takes value away."
Dampier says that asset allocators are better off investing in passive products, because the costs of trading funds are too high.
"If you’re making lots of asset allocation decisions, I think you’re better off investing in ETFs. If you trade a lot, I don’t think funds are a good place to be invested in, because they are too expensive."
Our data supports Dampier’s view. After costs, the average fund of funds across all of the multi-asset sectors has underperformed the average conventional portfolio over a five-year period.
For example, in the IMA Flexible Investment sector, the average fund of funds has returned 21.36 per cent over five years, compared with 26.9 per cent from the average stocks and shares fund. On average, funds of funds have also been more volatile.
Performance of portfolios over 5yrs
Source: FE Analytics
The same is true in the IMA Mixed Investment 20%-60% Shares sector: over five years, the average fund of funds is up 24.21 per cent, while the average stocks and shares fund is up 27.22 per cent.
Dampier believes many fund of funds managers try to be too clever by ignoring high-profile star managers in favour of hidden gems.
"If you can’t get access to a certain manager or fund, it makes sense," he said. "We have held Martin Lau’s Asian income fund [First State Dividend Advantage] for many years, but you can’t get in to it now because they don’t want any more assets. The same goes for Findlay Park American."
"However, it’s stupid to say you’re investing in something just to be different. You want to invest in the best managers you possibly can."
Dampier thinks it is worthwhile looking for the next big thing in a particular sector – particularly if the star is approaching retirement. However, he points out that this is a very difficult thing to do, and is particularly wary of backing young fund managers.
"Everyone’s always looking for the next Neil Woodford, but the problem is that more often than not, they disappoint," he said.
"In the past, I can remember everyone tipping the team behind the Schroder Income fund, but since they’ve gone to RWC, they haven’t done a great deal."
Nick Purves, John Teahan and Ian Lance left Schroders to take over the RWC Income Opportunities and Enhanced Income funds in 2010.
Dampier continued: "I think you’ve got to be particularly careful with the young guys, who have huge career risk when making their decisions."
"Back in 2000, Woodford had 15 years of great performance behind him, but he still came about six months away from getting the sack because he didn’t buy in to the dotcom craze."
"If you’re a young guy with only three or four years behind you, you run the risk of losing your career if you make a big call. You want someone who’s been there long enough so that they can make the decisions without worrying about losing their job."
In an article later this week, FE Trustnet will highlight some funds of funds that are suited to investors with a long-term time horizon.
