How long should you stick with an underperforming fund?

This article is part of
Guide to picking a fund

How long should you stick with an underperforming fund?

The debacle of the Woodford Equity Income fund, which sharply underperformed for several years but still had over £3bn of assets when it was forced to close, has shone a light on how long an adviser should wait for the fund’s performance to improve before selling. 

In a recent call with investors, the chief executive of fund house M&G John Foley said he expected about 60 per cent of his company’s mandates to be beating the market over a three year time period at any one time. 

Charlie Parker, managing director at Abermarle Street Partners, says the first thing to do is understand the reasons why a fund is underperforming, and particularly whether the underperformance is related to the fund manager's style being out of favour with the wider market.

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For most of the past decade, funds that deploy the value style of investing have underperformed.

Value fund managers place more emphasis on the valuation at which a company trades than on the growth rate of a company.

In a world of little or no growth, low bond yields and low interest rates, growth stocks and funds tend to perform best, and when those conditions are reversed, value funds perform better.

This is because in a world of higher interest rates, and bond yields, economic growth should be more robust, meaning more companies are growing, and so the rate of growth becomes less important than the price paid for the company.

Growth has outperformed value

The prevailing economic conditions of the past decade mean growth funds have generally outperformed value.

For this reason Mr Parker says: “As a general rule I don’t hold it against value managers that they have underperformed, because no value manager has performed for the past five years.

"I would look at it and say the fund manager has shown they are willing to be consistent, to stick to their beliefs, and that is important.”

He said that if a fund is underperforming but its style is generally in favour then he would want to know why.

Mr Parker says: “I would look at how they are doing compared to other managers with the same style, then I would look at what the context is.

"Are they being supported by their employer?

"What his going on in their lives, and in the firm in which they work.

"Of course there needs to be very good answers to those points, but there is no definitive answer in terms of what would make you sell a fund then, or what time period.” 

Alex Farlow, head of risk-based solutions at Square Mile Research, says a major red light for him would be if a fund manager changed the style of investing they have used throughout their career because they were underperforming.

He says: “It may be they tell you they haven’t changed anything, but then you notice they have invested in things that someone following that style would not be expected to invest in.”