When to Give Up On An Underperforming Fund

Investors often have to put up with periods of underperformance, but how long do you wait for a fund manager to turn the ship around?

Cherry Reynard 9 July, 2019 | 3:37PM

Warning signs

The very essence of active investing is that market sometimes gets it wrong. The active investor spots the anomaly and waits until the market catches up, revaluing the shares at a higher price. But how long should investors wait for that to happen?

The question is pertinent today in the wake of the problems at Woodford Investment Management. Neil Woodford has long defended the holdings in his portfolio: “Throughout financial market history, there have been occasions in which markets have become completely detached from valuation reality. We believe we are in one of these periods right now, with bubble-like characteristics increasingly evident and adding considerable risk to the investment backdrop,” he says.

“Ultimately, fundamentals are like a gravitational force that pull markets back into alignment with reality. That is why bubbles burst. Fundamentals always reassert themselves in the end.”

A previous time this happened - during the technology bubble - investors gave Woodford time and were rewarded. However, this time, it has taken too long for those fundamentals to reassert themselves and investors were not sure if the problems were short-term or whether Woodford had lost his edge.

But even if share prices of the stocks in the Woodford portfolio do start to reflect fundamentals, many investors may argue it was not worth the pain in the interim.

Structural Change vs Market Fashion

How do investors know whether they should cling on in the hope that share price will revert to historic norms? Andrew Impey, a fund manager on the SVS Albion OLIM UK Equity Income, says investors need to draw a clear distinction between structural change and market fashion: “Structural change is very different. Retail companies, media companies are subject to significant change and then you do have to change your mind. That’s not market fashion and they won’t go back to the way they were before. These companies need to change their business model significantly to survive.”

The same is true for fund managers. Gill Hutchison, research director at the Adviser Centre says the decision to hold or sell a fund depends on whether the fund is struggling because of style or “fashion” factors - that small caps are out-of-favour or that value investing is struggling - or because the manager is underperforming in isolation.

In Woodford’s case, investors may have been alerted to the problems because his performance was that much worse than that of his value-focused peers, such as Clive Beagles at JOHCM, or the Schroder Income team.  

Hutchison says: “If a fund’s performance is struggling because its style is out-of-fashion, we understand. However, if performance is struggling for factors that do not appear to relate to its mandate and natural style, we become nervous and conduct further analysis to identify whether stock or sector-specific issues explain the outcome.”

Fahad Kamal, chief market strategist at Kleinwort Hambros, says investors should always be alert to those pedalling the line “this time it is different”. There is some of this in the market today, as investors argue that high valuations for certain growth stocks can be sustained because of low interest rates and the influence of disruption.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
SVS Albion Olim UK Equity Inc174.50 GBP-0.28

About Author

Cherry Reynard

Cherry Reynard  is a financial journalist writing for Morningstar.co.uk.

Audience Confirmation


By clicking 'accept' I acknowledge that this website uses cookies and other technologies to tailor my experience and understand how I and other visitors use our site. See 'Cookie Consent' for more detail.

  • Other Morningstar Websites