Fund managers fall short of the mark

A decade ago, investors were piling into technology funds, tempted by 15 new launches from promoters such as Framlington, Gartmore and M&G.

Most of those new funds have now been closed or have merged, and anyone invested in the three technology unit trusts that have managed to last more than 10 years would have lost between a quarter and a half of their investment.
Three years ago, property funds were all the rage, with high-profile launches from New Star, M&G and Fidelity, among others. Since that blitz, the average property fund has lost a third of its value. And such dismal performance is not just restricted to specialist funds.

Over the past decade, the average fund in the UK all companies sector has returned just over 21%, which is equal to around 2% a year, according to figures from Trustnet, and well below the 34.2% average for money market funds - a proxy for cash - over the period.

However, that average hides a big disparity in performance. While a few did spectacularly well - the top three of Fidelity Special Situations, GAM UK Diversified and Schroder Recovery returned 190%, 150% and 134% respectively - more than a fifth of funds lost money.
Yet the past decade has seen huge advances in investment theory and risk management that were supposed to help fund managers do their job.

They have been given powers to use hedging and shorting, ostensibly to reduce the risk and volatility of their funds; sophisticated financial analysis techniques have been used to identify pricing anomalies and inefficient markets; and the information available about markets and companies has increased greatly.
However, this has just increased costs. Performance has, if anything, worsened and we have experienced two of the biggest-ever bubbles and crashes in less than a decade. Small wonder that investors prefer the safety of the building society, even at rock bottom rates.
Barclays Capital talks of a lost decade for equities and says shares have lagged well behind cash as well as corporate and index-linked bonds and gilts since 1997.

Tim Bond, global head of asset allocation at the firm, says the abysmal performance of shares is due to the "extreme overvaluation of equities at the start of the decade". But he believes that the opposite is now the case and that equities should beat bonds over the next decade.

Fundamental change needed

Others are less certain that equities will return to business as usual. Helena Morrissey, chief executive of Newton Investment Management, believes there needs to be a fundamental change in the fund management industry.

She admits that firms have been too ready to push products because they are in "hot" areas rather than assess what clients need.

"The industry has tended to launch funds in areas where there has been a lot of noise and that could be near the top of the market." The wave of launches in areas such as technology, property, BRIC (Brazil, Russia, India and China) and climate change, just as these markets peaked, underlines her point.

Morrissey argues that, for many investors, absolute return funds offering a premium over bank base rates are more appropriate than actively managed ones that aim to beat a particular index but not necessarily make them money.
The firm has produced a white paper outlining the changes needed in the industry. "We believe poor investment performance and, in some cases, mis-selling, have significantly undermined confidence in distribution-led models, it says.

"Investor focus is going to revert to the ability of individual asset management firms to meet investment objectives. This focus will take precedence over the next gimmick or trend intended more to raise assets than to meet investors' aspirations."
Andrew Wilson, head of investments at Towry Law, agrees that absolute return funds can be useful, provided investors are clear about what they are buying. While he is keen on the European Absolute Return fund launched recently by Gartmore and run by veteran hedge fund manager Roger Guy, he cautions that many fund managers lack proven expertise in this area.

He thinks benchmarking, where fund managers' performance is measured against a particular index or market, is one reason for the industry's failure to meet investors' needs. While a fund manager may be celebrated for losing just 15% of the value of the fund when the market has fallen 20%, for most investors that is a poor outcome.

"We prefer to manage the level of volatility and risk in [clients'] portfolios, and to work out how they can achieve their investment objectives given those restrictions."

Obsession with equities

Towry Law is also concerned that investors have been too obsessed with equities when a broader spread of assets would suit them better. "We had been banging our heads against a brick wall, but there is now a realisation that investors need greater diversity and a more sophisticated approach," says Wilson.

Investment managers also have to consider whether they have been upfront with investors about the products they have been selling and their underlying risks.

The most glaring examples were split capital investment trusts - highly complicated and over-engineered products that were promoted as reducing investment risk. Many were actually concentrating risk through a web of cross-holdings and debt.
And how many investors were aware that the performance of their endowment policies depended as much on the pattern of interest rates as on the performance of the stock market?

How many knew that the structured products that claim to offer a proportion of the return of an index or market, as well as guarantee the value of the investment, were actually dependent on the creditworthiness of the bank behind the guarantee?

That relationship was not made obvious in the marketing literature, but the collapse of Lehman Brothers - a big player in this market - and other banks has proved fatal for some of these products.

The Investment Management Association (IMA) defends the fund industry and points out that anyone who invested at the bottom of the worst recessions over the past 30 years - 1973, 1980 and 1990 - would have made substantial sums over the next 10 years as markets recovered.
The problem is that investors generally pile in at the top of the market, rather than at the bottom, encouraged by vigorous marketing campaigns and new fund launches. The IMA's own statistics show that investors have been shunning equities in favour of bonds this year. The industry needs to think about what kind of service it should provide when confidence returns.

This article was originally published in Money Observer - Moneywise's sister publication - in October 2009