Knowing when to avoid or sell a fund can be tricky. Rob Morgan highlights some of the warning signs Charles Stanley’s Collectives Research Team look out for and how they spot them.
Fund manager change
This is probably the most obvious warning sign, but it doesn’t necessarily make the fund a ‘sell’. Many funds are run by a team and have a rigid process that other personnel can adopt. Often it is the deputy manager of the fund that steps up as replacement, or at least another key member of the team who has a good knowledge of the stocks in the portfolio and is a proponent of the investment approach. This tends to provide a relatively smooth transition. In other cases, where there is considerable emphasis on the talent of a single person, it may be right to sell and move on.
Most investors appreciate the need to check their funds are performing satisfactorily, but it is important when doing so to make a fair assessment. The amount by which a fund has made or lost money is not really relevant. Performance should be compared to its sector (the average of other, usually similar, funds) or, ideally, its benchmark. This should be an index that most closely represents the make-up of the fund’s portfolio and helps test whether the manager is doing a good job.
It is also necessary to look over a sensible timeframe. One or two years of poor performance shouldn't necessarily be a warning signal – a fund manager’s style may be at odds with market sentiment over a short period, only for the tide to turn. Account should be taken of the fund manager’s style and approach and the reasons for the underperformance. This should help you decide whether it is a temporary blip or something more concerning.
Too much ‘asset gathering’
Sometimes fund management companies can put ‘asset gathering’ before performance – in other words marketing funds as much as possible with little regard to how the manager’s strategy can absorb the additional money. A rapid inflow into a fund can be an issue in itself, but worse is allowing the fund’s size to become so large it starts to compromise the investment process.
This tends to have the greatest impact asset classes that are not ‘liquid’, meaning hose that are harder to buy and sell quickly or in large quantities. For instance, managers of smaller companies funds with a lot to invest could find it hard to take the positions they want without moving the share price. Our Collectives Research Team aims to sift out the funds where they think a growing fund size could start to compromise performance, and prioritise managers seeking to grow assets sustainably and with a stable, diverse range of investors, with a view to closing the fund to new investment if necessary.
Poor charging structure
In a crowded market place that includes ‘passive’ or tracker funds with very low fees there is pressure on actively-managed funds to charge competitively. However, there are still managers charging a relatively high annual management fee, or a performance fee if the fund beats its benchmark. Performance fees can serve to closely align managers with their investors’ interests, but our Team is watchful of how any fee works to ensure the calculation is fair and will not result in onerous charges that adversely affect returns.
New launches in ‘hot’ sectors
A rash of fund launches in a sector that proclaim to be ‘the next big thing’ is something to be wary of – but it’s often ignored. Two examples I have witnessed during my career in the industry were the wave of technology and internet funds launched in the late nineties and the sudden appearance of lots of commodity funds in the mid-2000s. By the time many of these funds had got going the areas had peaked and poor returns followed.
No ‘skin in the game’
You wouldn’t trust a chef who doesn’t eat his own cooking, and it’s no different with fund managers. If he or she isn’t invested in the fund then it is worth asking why this is the case. If they believe in their asset class and their approach they should own it themselves, or otherwise have incentives that align them firmly with investors’ interests. This can be hard to find out for the average investor, but it is something our Research Team always covers in meetings with fund managers.
This website is not personal advice based on your circumstances. Investors should be aware that past performance is not a reliable indicator of future results and that the price of shares and other investments, and the income derived from them, may fall as well as rise and the amount realised may be less than the original sum invested. No news or research item is a personal recommendation to deal. Investment decisions in collectives should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and/or Prospectus. If you are unsure of the suitability of your investment please seek professional advice.