Inertia is the enemy of investors in actively managed funds

Despite valid criticisms, recommended fund lists serve an important function in

We are all familiar with the phrase ‘past performance is not a guide to the future’ and other such disclaimers. So does the future relative performance of a recommended actively managed fund or investment trust amount to the toss of a coin? Analysis of returns from recommended funds – and their relative performance against a recognised peer group – suggests that is indeed the case.

Wealth manager SCM Direct, founded by Alan and Gina Miller and specialising in passive investment strategies, recently took a very critical view of the performance of funds listed in the Hargreaves Lansdown Wealth 150*.

Hargreaves Lansdown (HL), the UK’s largest online investment platform with assets under administration of £79 billion, has operated its Wealth 150 since 2003. Quoting performance figures from November 2003 to end July 2017, it recently claimed: ‘We are proud of the performance of our fund choices to date. They have on average outperformed their most appropriate benchmark indices by 6.47 per cent, and sector averages by 12.04 per cent, although not every fund has outperformed.’

Alan Miller, SCM’s chief investment officer, expresses surprise at these claims, because they do not tally with research that SCM conducted early last year into the three-year performance of ‘best buy’ fund lists produced by HL, Tilney Bestinvest, Chelsea Financial Services and Charles Stanley Direct. SCM found that ‘on average, funds picked by Hargreaves Lansdown would have come 49th out of a field of 100. Those picked by Bestinvest would have finished 52nd, Charles Stanley 55th and Chelsea 56th.’

Following HL’s recent claims, SCM has conducted further research into the performance of Wealth 150 funds. The firm argues that it is surely more relevant to HL’s current client base (950,000 compared with 188,000 in 2006) to focus on the three- to five-year performance of HL’s recommended list, rather than nearly 14 years of average past performance for the Wealth 150.

As chart 1 and chart 2 (below) reveal, this timeframe shows the performance of the HL Wealth 150 in a less flattering light. Among the 2012 list of funds, there is a fairly even dispersal of funds between the first and fourth quartiles of their official Investment Association (IA) sectors. Only 21 per cent of the 110 funds that SCM analysed (from a cohort of 124) were among the top performers. The 87 funds analysed on the 2014 list fare little better, with fourth-quartile performers (36 per cent) outnumbering those in the first quartile (28 per cent).

We asked HL to respond to SCM’s analysis of the Wealth 150. Laith Khalaf, senior analyst at HL, argues: ‘Looking over three or five years is just a snapshot over a relatively short timeframe, and also doesn’t take account of any additions or removals to the list made in that time. We therefore don’t think such an analysis is particularly meaningful.’

HL declined to say which of the Wealth 150 funds from 2012 and 2014 remain on the list today and how they compare against peers. So we asked SCM if they could find out. Miller was happy to help. He says: ‘There were 124 funds within the January 2012 HL Wealth 150 list, of which 47 are still on the list today, meaning 38 per cent have survived. There were 93 funds within the January 2014 HL Wealth 150 list, of which 54 are still on the list today, so 58 per cent have survived.’

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HL argues that a performance period of five years is not particularly meaningful, but we disagree. We therefore assessed how those 47 surviving funds from the 2012 list have fared in the period from 1 January 2012 to 31 August 2017, as per SCM’s original performance analysis. One would expect the superior relative performers to outnumber the poorer performers, which is indeed the case. Among funds that can be compared against an IA sector average, 19 were in the fi rst quartile, 15 in the second, four funds were in the third quartile and five were in the fourth quartile.

However, to be fair to HL, it does inform clients about changes to the Wealth 150. Khalaf says: ‘When we remove a fund from the Wealth 150, we email all investors to let them know it has been removed and refer them back to the remaining funds on the Wealth 150 for consideration.’

How do our Rated Funds stack up?

We were naturally curious to discover whether performance of Money Observer’s own Rated Funds since recommendation has also been as random as SCM’s research into the HL Wealth 150 would indicate.

At first glance, the answer is yes. We referenced the 2014 list of funds; this was updated in August 2014 to widen the choice to 196 funds, 191 of which are directly comparable against peers (the other five were specialist choices that are difficult to compare against a peer group). Over three years to 1 August 2017, 29 per cent of the Rated Funds are in the top quartile of their sector, 25 per cent in the second, 18 per cent in the third and 28 per cent in the fourth quartile (see chart 3).

So, on the face of it, there has been a similar random disbursement of relative performance of Rated Funds to HL’s Wealth 150. But which constituents of the 2014 list continue to be Rated Funds today? Over the course of three subsequent annual reviews, the poor performers have been weeded out (see table 1).

Only three of the 53 funds that are in their official sector’s fourth quartile after three years are among our Rated Funds for 2017, and eight funds out of 35 in the third quartile have retained Rated status. This suggests that investors who follow our Rated Funds would, therefore, have a very good chance of avoiding poor performance relative to similar funds.

Bear in mind, too, that relative performance is not the same as absolute performance. Investors in funds pursuing a variety of strategies have made decent gains in the past three to five years. Among all 196 Rated Funds from August 2014 – which include the poor relative performers subsequently removed – the average gain has been 42 per cent. Only three funds, all from our 2014 Specialist asset group – BlackRock World Mining, First State Global Resources and Investec Global Energy – have lost money over the period.

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The bald relative performance figures for funds quoted above also need to be put into context. Our Rated Funds list differ from most other recommended fund lists, because they have always contained investment trusts as well as open-ended funds. We also aim to include lower- and higher-risk options, as well as ESG (environmental, social and governance) funds in many of the 16 asset groups in which the Rated Funds sit.

These distinctions, where both a fund’s aims and its performance influence inclusion, in turn influence relative performance against a peer group. In this long bull market, for example, many of our lower-risk choices will have lagged their more gung-ho cousins.

Setting these distinctions to one side, a quick analysis of performance of Rated Funds from 2014 over the past three years – regardless of whether they have retained Rated Fund status – shows that, on average, investors who follow them have done well in absolute terms. Table 2 shows that is especially true of Rated Funds in the Japan, US and global growth asset groups, plus those in UK smaller companies and Europe equities.

Although SCM’s research into the Wealth 150 is illuminating, I disagree with the firm’s comments in regard to investor behaviour. Miller says: ‘Many clients, particularly retail clients once they buy a fund, rarely change it. Furthermore, if the fund has performed badly, many individuals will decide to keep the fund on the view that it is a bad time to sell or because they do not want to crystallise a loss. Thus, a fund might come off the HL Wealth 150 after years of poor returns or for another reason, but how many HL clients holding that fund would sell in practice?’

In my opinion, this observation of investor inertia belongs in the past. The abolition of commission-based investment advice in 2013 has heralded a new era in which individuals have been forced to either pay high fees for independent financial advice or to make their own investment choices.

According to the Financial Conduct Authority, fund assets held via UK platforms such as HL, Bestinvest and Interactive Investor (which publishes Money Observer) had grown from £100 billion in 2008 to more than £500 billion at the end of 2015. It surely follows that private investors now pay a great deal more attention to their fund choices than formerly, and switch when necessary.

In fast-changing financial markets, inertia is not a position that private investors can afford to adopt. While we can’t know how an actively managed fund will perform in the future, relatively or absolutely, recommended fund lists serve an important function in a world where financial advice is no longer ‘free’.

That is what Money Observer aims to achieve when compiling its annual rota of Rated Funds. From next March, we will also be including passive index-trackers, as well as conducting a formal quarterly review of all the constituents. 


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