- Periods of underperformance from funds may prompt current investors to reconsider their position
- But they can also highlight buying opportunities for new investors
- Investors should look for a consistent philosophy from fund managers
- Three funds and trusts looking for a bounce back
Dan Coatsworth, investment analyst at AJ Bell, comments:
“Investing in funds can be a journey of highs and lows. When a fund experiences a period of underperformance, it can prompt investors to wonder whether it offers up a buying opportunity with the hope of a rebound, or a signal to exit. For current investors, the question is whether they should stay the course or seek new options.
“Previous research has shown that fund managers let go after three years of underperformance often delivered positive returns after that point – frequently surpassing those of their replacements*. This suggests that a temporary downturn may not always indicate the end of a fund’s run of good performance.
“While a three-year period has become an unofficial benchmark for assessing fund performance, it’s crucial to recognise that fund managers are unlikely to outperform an index or peer group consistently. Portfolio choices that diverge from the benchmark inherently lead to varying results over time.
“There are funds that, after three challenging years, have shown remarkable recoveries. For instance, Temple Bar Investment Trust, managed by Ian Lance, faced a tough stretch from 2018 to 2021 but rebounded strongly, securing a top quartile position among its peers. Similarly, Jupiter UK Income has returned to strength, though recent changes in leadership – following Ben Whitmore’s departure – mean the fund is now under the guidance of Chris Morrison and Adrian Gosden.
“Rather than purely focusing on performance, investors should look at several other factors when deciding whether to stick with or invest in an underperforming fund. A consistent investment philosophy and process is often a hallmark of successful funds, regardless of market conditions. If a fund manager deviates from their established approach, it may signal potential for future underperformance due to ‘style drift’. Noteworthy changes, such as the number of stocks in a portfolio or the frequency of trades, could also indicate shifts in strategy. Equally a switch of fund manager can impact a fund’s trajectory. While a fresh perspective can sometimes enhance performance, the departure of a seasoned manager may mean a substantial shift in strategy.”
*A study by Amit Goyal and Sunil Wahal in 2006 examined over 3,500 institutional hiring and firing decisions by pension plan sponsors across a 10-year span.
Three funds and trusts looking for a bounce back
- Slater Growth
“Mark Slater and his team have delivered an excellent long-term track record managing the Slater Growth fund, which has a total return since inception in 2005 of 516%, compared with the 228% return of the IA (Investment Association) UK All Companies index at the time of writing.
“Over the past three years the fund has underperformed its peer group by a wide margin, down 27% compared with a 5% gain for the IA UK All Companies index.
“The pedigree of the manager suggests the fund has good bounce back potential. Slater applies a proven investment process that starts with a screening of the UK universe across several criteria, including the price earnings ratio to growth rate, popularised by his father Jim Slater, and sustainable earnings growth.
“The team then conducts thorough in-house research and if they still like the business they meet company management. An assessment of the risks and opportunities is then carried out before a final decision is made.
“Slater puts recent underperformance down to a big de-rating in the small and mid-cap parts of the UK market plus rising interest rates, accentuated by fund outflows. Slater believes this section of the market is so beaten up it is now ‘pretty resilient to bad news’.
“The manager points out that historically when small companies as a group trade on under 10 times earnings they have subsequently rallied around 60% over the following two years. This part of the market now trades on a price to earnings ratio under nine times, according to Slater.”
- Montanaro UK Smaller Companies
“Montanaro Asset Management was set up in 1991 and has 16 analysts and fund managers dedicated to picking smaller stocks, which could just make them the biggest small-cap team in the UK.
“Founder and chief executive Charles Montanaro chose the closed-end investment trust structure for his high-quality growth strategy as it meant not having to buy and sell stocks depending on inflows and outflows.
“The team looks for simple businesses in distinct niches, which makes them less vulnerable to the vagaries of the economic cycle, and they must be profitable. There are no early-stage or venture-capital style investments in the portfolio – companies must be money-making before they even get on the radar.
“Typically, small-caps outperform large-caps over the long term – with some of them eventually becoming large-caps in the process – and the dearth of publicly-available research means there are plenty of opportunities for the Montanaro team to find undiscovered gems.
“Unusually, especially for a small-cap growth strategy, the trust pays a regular dividend of 1% of its net asset value every quarter, equivalent to a yield of 4% per year.
“The fund generated a 1,397% total return from its inception in 1995 to August 2021, but over the past three years it has struggled as the small-cap value investment style has outperformed small-cap growth amid the sharp rise in interest rates.
“The fund was back on track in the first half of 2024, outperforming the index as it became apparent rates were set to fall, but the sluggish pace of cuts has held it back in the third quarter despite positive results from its portfolio companies.”
- RIT Capital Partners
“It’s been a challenging three years and a lost decade for capital preservation and growth fund RIT Capital Partners, whose stated purpose is ‘to grow your wealth meaningfully over time, through a diversified and resilient global portfolio’.
“FE Fundinfo data shows the £2.65 billion cap trust has produced a loss of 27% over the past three years, while performance lags the MSCI AC World (50% £) benchmark over 10 years, which is reflected in a near-30% share price discount to net asset value (NAV).
“A difficult period for NAV performance in 2022, concerns over the valuations of unquoted investments and a headwind from cost disclosures drove a sharp de-rating and left investors questioning what role RIT Capital played in their portfolios. And as Deutsche Numis explains, ‘many were left without the information to answer these questions and we believe this has contributed to the selling and lack of demand’, but the broker believes RIT Capital’s NAV has ‘potential to deliver an attractive return profile in future and the discount offers a value opportunity’.
“More recently, manager Maggie Fanari has been articulating her plan to revive the trust’s fortunes to investors who’ve seen an uptick in portfolio performance, while buybacks continue apace and falling interest rates should offer a tailwind.
“As of 30 September 2024, NAV was £26.19 per share, up 1.5% from the previous month, and meaning the fund had generated a positive NAV total return of 8.8% year-to-date. Recent performance has been driven largely by the quoted equities book, boosted by the rally in Chinese holdings, with private investments and uncorrelated strategies chipping in with positive contributions.
“It is also worth noting that many of RIT Capital Partners’ largest direct investments are profitable companies with growing earnings, while its private fund portfolio includes some of the globe’s best performing funds, which are well positioned when the IPO (initial public offering) window opens.”
