It can be hard for an investor to let go of a top-performing fund especially after it has made a lot of money. However, the law of averages suggests that the longer a fund outperforms, the more likely it will eventually start to underperform and revert to the mean.
But how can an investor tell if their top-performing fund is coming to a peak? Trustnet asked three expert fund pickers to share some warning signs for investors.
Jim Wood-Smith, chief investment officer at Hawksmoor Investment Management, said one warning sign could be a growing popularity of the fund, specifically, “when everyone else wants to be on the bandwagon”.
“The important part to understand here is the difference between wanting to be on the bandwagon and actually buying the ticket,” he said. “The first part is the good bit – when everyone else starts to spot that your star fund is where it’s at.
“The bad bit is when they all have bought it – when the last buyer has bought, there are by definition no more buyers.”
He said investors need to be wary of the rate at which the fund size is increasing, and the number of times it is mentioned that it is a must-own fund.
Wood-Smith (pictured) explained: “The cliché is that ‘if it’s in the press, it’s in the price’. 
If attending a seminar, he said investors should observe if it is “packed to the virtual rafters with adoring investors wanting to hear why they have been so clever in having bought the fund”.
“If it is, just remember the perils of confirmation bias and click the ‘leave’ button,” he added.
Wood-Smith also highlighted the popularity of the actual fund manager.
He explained: “Have they started to speak hubristically about how brilliant they are? Are they starting to lose perspective on whether they are genuinely skilful or merely lucky with their timing?
“Is it becoming more difficult to speak to the manager, or are you directed to the ‘number two’ on the team, or the sales team?
“Are you made to feel that you are privileged to be allowed to invest into the fund, or are you still made to feel as the manager believes he or she is privileged to be allowed to manage your clients’ money?
“What does the website look like? Are there lots of photos of the manager looking just the right shade of smart casual?
“What is the balance between the photos of your star manager and meaningful facts about the fund? The right mix is roughly 1-99 per cent.”
He added: “If the website ever says something akin to ‘widely believed to be amongst the best investors of his/her generation’, you should demand the return of your money immediately.”
Wood-Smith also said it might be worth analysing what stocks are driving the fund’s performance, to determine if it is becoming increasingly reliant on a small number of large positions.
“Funds charge their fees as a percentage of the size of the fund; their mission is to earn more by growing more. And this is easiest achieved by convincing investors to keep buying,” he continued.
“This is a very powerful incentive to take ever greater risks to keep performance at the top of the tree; the best way to try to understand when this is happening to keep looking at the actual portfolio.
“A small number of managers play the long game and will be open and honest with their investors about whether they themselves actually think it is a bad time to be buying, or they might close or soft-close a fund when it reaches a certain size,” he said. “But they are the minority.”
Rob Morgan (pictured), analyst at Charles Stanley Direct, agreed that a fund shouldn’t be overly reliant on a single individual. 
He said: “This makes succession planning more difficult and there could be heavy outflows if the manager moves on, which can make things especially difficult for those taking over.”
Becoming increasingly reliant on a small number of large positions, he said, is worth considering with any fund, but not necessarily a warning sign.
“I would say the biggest thing is the size of the strategy versus the opportunity-set the manager has,” he said.
“Clearly, this is more relevant for smaller companies and more esoteric areas where liquidity can be more of an issue; but you would have to consider any fund running into the tens of billions to be a ‘supertanker’ and that the opportunities and options of the manager might, at least at the margin, be compromised.”
As such, he warned that a fast-growing fund can be worth keeping an eye on.
Indeed, Jason Hollands, managing director at Tilney Investment Management, also advised investors to watch out for a significant change in fund size.
“Most investment strategies will ultimately have capacity constraints, but there can be a tension between the investment approach and the commercial attractions of hoovering up loads of assets,” he said.
“A fund that has delivered strong performance in the past by investing heavily in smaller companies, is going to be a lot less scalable than the likes of Fundsmith which has always focused on very large, global companies.”
Within the £21.9bn Fundsmith Equity fund, the average market capitalisation of companies is £142bn.
“If a fund gets too big, it will close off parts of the market to the fund and make it harder to move the portfolio around quickly,” Hollands (pictured) explained. “The fund will either have to invest in more positions, and in so doing water down the focus on high conviction holdings, or increasingly focus on very large, highly-liquid stocks.” 
While Hollands prefers funds with a concentrated portfolio of high convictions, he agreed that it could be a source of concern if it becomes too exposed to a cluster of very large positions.
“This can be a particular problem with investment trusts, where the rules on position size are less strict,” he said.
Another warning sign he pointed to is if a manager starts turning over the portfolio at elevated levels.
“I much prefer to buy and hold managers who invest in businesses rather than try and trade positions,” he added. “When a fund portfolio starts seeing an unusually high level of turnover, it might be an indication that the manager lacks conviction or is being too influenced by short term market noise.”
The main thing to watch out for, said Hollands, is that a top-performing fund stays faithful to their investment approach and philosophy.
“When a popular, once stellar performing fund starts changing its approach, that really is a sign to reappraise the case for holding it and the textbook example here is the now infamous Woodford Equity Income Fund,” he said.
“In the latter case, a manager who built his track record investing in FTSE 350, dividend generating companies took his eye off the ball and strayed into investing in early stage, illiquid AIM-listed and unquoted ‘growth’ companies, many of which paid zero dividends.
“The alarming transformation of the fund was there for all to see by the start of 2018, a year and a half before it was suspended, but unfortunately the fan club didn’t look beneath the bonnet.”
One last warning sign investors should watch out for, he said, is if a co-manager pops up.
Hollands explained: “This is often a sign that handover is happening ahead of retirement or the previous lead manager is stepping back.
“Too often when a prominent manager leaves and their junior partner takes over the reins, the fund company will claim ‘Doug has really been running it day to day for the last couple of years’.”