Investment fund managers are famously paid a lot of money for their expertise. Investors pick up the tab for their bumper wages and bonuses by paying fees on their funds and can rightly expect that, in return, their manager will deliver strong returns – and beat the market.
Yet, you may be surprised to discover just how few of these well-paid experts consistently deliver better returns than the cheaper alternative of an index tracker fund, which just follows an entire market.
The sad reality is most active funds fail to deliver – and have done for a long time. Over the past ten years, only 16 per cent of global equity funds have beaten MSCI World index trackers, according to analysis by investment platform AJ Bell. And just 6 per cent of US-focussed funds offered to UK investors have beaten America’s S&P 500 index over ten years, according to Bestinvest.
That means most investors would have been better off putting their money in a cheap fund that tracks entire markets, known as a passive fund. Investors pay a premium for a fund manager to pick winning stocks. The typical charge on a global active fund is 0.8 per cent versus 0.1 per cent for a global index tracker.
Of course, there are some ‘active’ funds that are delivering market-beating returns. But when funds that track the global market, like Fidelity Index World, return 76.2 per cent over the past five years, it can be difficult to justify paying more for a human manager.
So, are there markets where active stock picking consistently outperforms and how do you know when it’s time to ditch an underperforming fund manager?
Calling time: How do you know when it’s time to ditch an underperforming fund manager?
How to know when it’s the right time to sell
It may be tempting to cash out of an investment that has performed poorly. But if you are thinking of scrapping your fund manager, the first step is to try to understand why your active investment has disappointed.
Find out if the entire market has had a hard time or if it’s just your fund that has performed poorly. You can do this by looking at the fund’s benchmark and see how it has fared compared to the average manager in its sector.
You should be able to see this on the monthly fund fact sheet, which provides a snapshot of an investment fund’s performance, holdings, risk, and strategy.
Dan Coatsworth, of AJ Bell, says: ‘No fund manager can be expected to do well every single year. You need to have more patience than you might think. Sometimes their style of investing will go out of favour but it doesn’t mean they won’t every do well again.’
For example, if a ‘value’ manager, who invests in stocks that are deemed to be priced at less than their intrinsic worth, is lagging the benchmark but behaving in line with their ‘value’ peers, that isn’t usually cause to panic, says Kamal Warraich of Canaccord Genuity Wealth Management.
Instead, it may simply mean that the fund’s style is out of favour at that point in time, he says.
However, Coatsworth warns: ‘If the manager’s style is doing well and the rest of the market is, but they are still not performing, after two years it’s reasonable to reconsider your investment.’
Then it’s time to do a deep dive into what the root cause is, Coatsworth adds. The investment process may have been changed or is it a case of bad stock picking? Another major signal to look out for is if the fund manager leaves or a new one is appointed to run the fund. Managers are paid to take an active role in choosing where the fund is invested so their personal approach will have a direct impact on your returns.
When a new manager is appointed, look into who they are and where they have come from. Coatsworth says: ‘They may have been involved with the fund before and recently promoted. That’s encouraging people they will know the process but it doesn’t mean just anyone can slot into the job.’
If the new manager has joined from another company, investigate how their funds performed and whether they ran a similar type of fund – if not, then this will be a red flag.
Seeing a fund manager’s name popping up in the press regularly can also be a worrying signal – whether it’s good or bad news.
A handful of fund managers have been mired in controversy in recent years. Coatsworth says: ‘If you have controversy around an individual, you have to question if you want this person making all your investment decisions.’
But even when a fund manager is praised regularly, it may not be the good news it appears to be.
He adds: ‘These managers are in the news because they’ve been doing well. But like with the hype around a meme, stock that everyone you know – even non-investors – are talking about, may be a sign that it’s time to diversify.
‘You have to question whether a person can continue to be absolutely amazing for ever.’
Famous manager Terry Smith, who manages his flagship Fundsmith Equity fund, has struggled to deliver in recent years. His fund has lost 5.7 per cent over the past year, while the global stock market is up 14.2 per cent. The picture isn’t much better over three years – the fund has returned just 8.5 per cent, compared to global equities’ 38.9 per cent.
Coatsworth says: ‘Terry Smith is known because of how well he has picked investments in the past. But he’s had a run of bad luck and consistent underperformance. Lots of people’s patience has run out but it doesn’t mean everything he does now is going to be bad.’
Where managers struggle the most
When it comes to funds investing in the US stock market, Andrius Makin, a portfolio manager at wealth manager Killik & Co, says the dominance of the ‘Magnificent Seven’ stocks have made it very difficult for US and global active funds to beat index trackers. These seven giant stocks, Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla, make up close to 33 per cent of the S&P 500. Meanwhile, a staggering 70 per cent of the MSCI World global stock market index is in US shares, with the Magnificent Seven accounting for 23 per cent of it.
Makin says: ‘Nearly a quarter of the MSCI World is in a handful of stocks, so unless you are holding those stocks it is extremely unlikely that you are going to perform better than the index.’
At a time when investors are wary of over-excitement surrounding AI and the high valuations put on these tech giants, this leaves fund managers in a tricky spot. By making the call that some may not be worth holding, they run the risk of falling behind the index if the tech giants’ share prices keep rising. But by holding them they leave themselves unprotected if they suddenly fall.
Where can fund managers shine?
It isn’t all bad news for fund managers though. There are areas where they have beaten trackers over time. These include bonds, smaller companies, Asian stock markets and emerging markets, like Brazil and India. Here professional investors, who can put in the time and effort to research companies that are not well-followed by analysts and other investors, can reap rewards.
Over the past ten years, 47 per cent of UK small cap funds have beaten passive rivals, according to Bestinvest’s data. Here, the Fidelity UK Smaller Companies and JPM UK Smaller Companies funds are among the top performers.
Is there still a place for active funds?
Ennion believes active funds still have an important place. He says there are fund managers with strong track records who have shown time and time again they can stick to their process.
These managers will inevitably rise to the top, he says, citing Alex Wright, manager of Fidelity Special Situations as a case in point. Over five years the fund has returned 79.3 per cent compared to its benchmark’s 37.1 per cent.
Makin agrees. He suggests holding index funds as the core of your portfolio and then adding active funds, which offer you something you can’t achieve with trackers. However, Eugene Gorbatikov, an analyst at investment data firm Morningstar, is less convinced. He says: ‘Unless you have strong conviction in an active manager, a passive approach is more prudent.’
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