Why the Worst Performing Funds Can Be the Best Investments

Don’t let a temporary slump change your long-term investment plan. If investors quit these funds after periods of underperformance, they would have missed out on subesquent gains

Karen Kwok 22 March, 2016 | 4:10PM
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Investors, listen up: One year of underperformance does not necessarily mean a fund will lose investors’ money in the long run. Investors who dumped funds after short periods of underperformance would have missed out on spectacular gains when the fund performance rebounded in the years after, according to data from Morningstar Direct. 

A year after the slump the fund rebounded strongly by 103% 

Records in Morningstar Direct show even the top funds awarded with a positive Morningstar rating of Gold, Silver or Bronze have periods of underperformance. But if you stick with these top rated funds, trusting the analysts’ view, in the long run they deliver stellar returns, proving that investors might not let a market slump change their long-term investment plan.

Buy low sell high is an obvious mantra but few investors actually do it. When markets are low their confidence is also low so they wait. But this is the time you should be diving in,” head of investing at AXA Self Investor Adrian Lowcock said recently.

This situation describes what happened in 2008 to JPMorgan Emerging Europe Equity Fund, a now Bronzed Rated fund run by manager Oleg Biryulyov. This fund seeks to provide long-term capital growth by investing primarily in equity of companies in European emerging markets countries, including Russia.

Before the global financial crisis in 2008 the fund had built a strong performance record, winning 44.5% in 2007 and 29.9% in 2006. But when the global financial crisis swept the world in 2008 many countries in emerging Europe proved vulnerable because of high levels of private debt to foreign banks and foreign-currency exposure.  And the JP Morgan Emerging Europe Equities fund was hit particularly hard, losing 61.8% in that year alone.

Proving what a bad year it was across the entire sector; even with that loss, the fund still outperformed the MSCI Emerging Europe index by 4.7%.

However, a year after the slump the fund rebounded strongly by 102.6% in 2009, beating its benchmark by a sizable 43%. Then the fund maintained a steady positive return of 30.5% in 2010 and 22.3% in 2012, proving fund manager’s successful longer-term investments approach. Investors’ reaction to this outperformance, in 2009 to 2010, investors bought more than £39 million of this fund. Investors who have invested in this fund continuously would have earned profits in this period of time.

The same scenario can be found with the top rated developed market equities funds. Looking back in the past 10 years, AXA Framlington Monthly Income Fund, CF Morant Wright Japan Fund, Schroder European Opportunities Fund did not rebound as significant as the emerging Europe fund, given the less volatile nature of these sectors. However, these positively rated developed market equities funds illustrate a strong long-term track record despite a one year loss.

The AXA Framlington Monthly Income fund was the strongest example. The fund underperformed in 2007, losing 13.2%, but since then it posted consecutive positive returns, gaining 30.3% in 2009 and 16.3% in 2010. The now Bronze Rated fund presents a strong 9.9% three years annualised return and a 8.6% five years annualised return.

Another longer term capital growth funds, CF Morant Wright Japan Fund also has a strong long-term annualised return despite of its loss in 2006. The fund had a 7.6% three years annualised return and a 9.1% five years annualised return.  Schroder European Opportunities fund had a 7% five years annualised return. The fund gained 20.6% in 2012 and 31.8% in 2013.

Which Funds Could Be a Buying Opportunity?

Examples above effectively prove that even highly rated funds can have bad years once in a while. However they manage to outperform the market over the long term.

Therefore investors should not fault a fund during periods of underperformance. If a fund receives a positive Morningstar rating of Gold, Silver, or Bronze, it means Morningstar analysts think highly of the fund and expect it to outperform over a full market cycle of at least five years. When these positive rated funds experience a loss, it might be a bargain to be included in your portfolio.

Amid the recent market volatility, quite a few funds posted losses, however Morningstar analysts still retained their conviction in these funds. Some Gold, Silver and Bronze funds have a one-star rating, meaning that they have significantly underperformed in recent years compared to the peer group average. So a fund with a one star rating but a Gold, Silver or Bronze award might indicate that this could be a good opportunity for long-term investors to buy the fund at a discount. Below, we have identified three of these funds using Morningstar’s free Fund Screener.

Legg Mason Royce US Small Cap Opportunity Fund

This Silver Rated fund has struggled in 2015 after three years of consecutive gains. Investors should not be disheartened by its underperformance in 2015 as it has a strong 6.9% five years annualised return. Prior to 2015, the fund had a stellar three years, gaining 3.9% in 2014, 37.9% in 2013 and 16.2% in 2012.

Morningstar analysts Lena Tsymbaluk says that this fund is a strong offering within the Morningstar US Small-Cap Equity Category, however warning that investors must be able to tolerate the extra risks that come with the approach. 

CF Miton Defensive Multi Asset Fund

Despite this Bronze Rated fund losing cash in 2013, down 0.4%, the fund delivered consecutive gains in 2014 and 2015 by 2.9% and 1.9%. The fund has a 1.7% five years annualised return and a 3% 10 years annualised return.

Morningstar analyst Randal Goldsmith says that this fund is a strong choice for investors seeking real returns and capital preservation. The fund managers bring a solid track record from PFS Darwin Multi Asset and M&G Cautious Multi Asset, which show cumulative outperformance of the GBP Moderate Allocation category. 

Neptune Global Equity Fund

With a Bronze Rating, this fund has posted consecutive gains since 2012. In 2013, the fund delivered its best performance in four years by 22.1%. The fund has a 3.4% 10 years annualised return. 

Benefiting from an excellent fund manager in Robin Geffen, who has more than 30 years of investment experience, this fund remains a good choice for investors who are cognisant of its risks, Morningstar analysts say.

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.

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About Author

Karen Kwok

Karen Kwok  is a Reporter for Morningstar.co.uk