The industry is still reeling from the news of the Woodford fund closure, with investors left in limbo as to when they will get their money back.
But the saga has also brought two more general considerations into sharp focus: first, whether star fund managers are the answer at all, and second, what red flags investors need to look for to ascertain whether a fund is in trouble.
Where star fund managers are concerned, even the handful of incredible ones have periods when they underperform the market. Take Warren Buffett, who has more than doubled annual returns compared to the S&P 500 between 1965 and 2018. But it wasn’t all smooth sailing for Buffett: during the brutal 1973-1974 bear market, his company Berkshire Hathaway lost 50 per cent, versus the S&P’s loss of under 37 per cent.
So while performance is important, sometimes it’s not the best move to drop a fund manager as soon as they start to have a rocky period.
In fact, performance is far from the only aspect you should consider. Sometimes you need to look beyond the obvious figures or costs when selecting funds, and pay attention to soft factors which will help you to find the cracks. Here are four warning signs that could be symptomatic of an underlying problem.
1. Staff churn
If staff are fleeing faster than kids leave school at the end of term, this is a sign to look more closely. It might not be a happy ship.
If a lot of fund managers are leaving an asset management group, it could hint that they don’t feel the environment will help them generate good outcomes for investors. And if a lot of supporting analysts are leaving, it might be a sign that the team structure is too top-heavy. But whatever the reason, high turnover is rarely the sign of a happy fund.
2. Culture shock
Also consider whether the environment at the fund group encourages innovative thinking.
Does the fund manager rule in a bubble, or are their ideas challenged productively? Does the fund manager get on with the chief executive and board? Is the fund manager spending too much time marketing the fund, and not enough on day-to-day investing?
It should raise a red flag if a fund manager has multiple roles in the business. For example, if they also hold a chief executive role, there is a risk that they might be overstretched.
Also, are there rumours of staff falling out, or of general consternation? Wealth managers often get to meet the fund teams, so you could ask a financial adviser whether the staff seem to be on the same page, or whether one person was dominating without giving others the opportunity to contribute.
3. Change of tack
Another warning sign is if the fund manager diverts from its philosophy for how it will invest your money. A swift change in strategy can often result in poor stock-picking, so it’s worth your while digging a bit deeper.
Is the manager buying companies that look odd choices for the strategy in question? For example, star manager Terry Smith from Fundsmith has consistently said that he does not like investing in banks, so it would definitely raise eyebrows if Barclays suddenly appeared in his top 10 holdings.
4. Asset gathering exercise
It is important that funds are transparent with investors about when the amount of money they are managing might affect their ability to manage the strategy effectively.
So if a fund starts telling investors that it is at full capacity, this could be a positive sign, suggesting that they are focused on performance rather than gathering assets, which is usually reassurance that you are dealing with a fund with the right ethos.
Stockpickers should be prepared to “soft close” their fund when they feel they cannot deliver expectations. But it’s also worth noting this might just be a sales tactic.
When you are looking at specific funds, remember that investment always involves a degree of risk – funds can go up and down in value, and investors always risk losing money that they put in.
Crucially, buy into a fund with a clear investment strategy that is implemented consistently. The star name isn’t important, but it is imperative that investors weigh up the facts.
Like good detectives, look at all the clues that are available before choosing a fund to invest in. Doing your homework first will definitely stand you in good stead.