When should you keep faith with an underperforming active fund?
by Alexander Beard, on Nov 11, 2015 5:47:38 AM
Investors who entrust their savings to active fund managers do so in the hope they will achieve market-beating performance. When the fund starts to dip, it is possible that some investors may forget that short-term bouts of underperformance must be endured along the road to potentially superior long-term results. Ultimately, whether to stick with an underperforming fund is the investor’s decision to make… and a very difficult one at that!
First and foremost, an active portfolio of shares, or other assets, is expected to be positioned differently from its benchmark. Only this way does a fund offer opportunity to outperform. The hope is for active managers to successfully outperform their peers and benchmark, but it is part and parcel of active investing for even the most skilled managers to undergo short-term periods of underperformance.
Investors can sometimes focus on one or two-year performance; or sometimes even less. Typically, most experienced investors would recommend a focus on a considerably longer timeframe, mindful of active fund managers who consistently underperform over a prolonged period. It is important to delve a little deeper before giving up the ghost – considering the reasons behind a fund’s performance, whether this appears to be temporary and whether the strategy remains intact. Some observers generally view it positively if a manager has consistently adhered to their original strategy throughout their tenure.
Investment strategies will fall in and out of favour, or will not be suited to a particular market environment. This means even great managers can underperform over the short to medium term but, if their approach is sound, generally they are often vindicated in the long run, although there are of course no guarantees.
It is also worth considering why an investment with a particular manager was made in the first place and thinking about what a manager is trying to achieve. If their main objective is to offer some capital protection in falling or turbulent markets, consider whether they have been successful in doing so. This type of portfolio is likely to be conservatively positioned, in which case it would be natural to expect the fund to lag a rapidly rising market.
In reality it can be extremely difficult sticking with and maintaining conviction in an underperforming manager. Remember, investing is a long-term game and making a decision purely on short-term performance can be a mistake. Looking at managers who have managed money through at least one full market cycle (around 10 years) can provide an interesting view of how they perform in a variety of market conditions. If the current environment is more suited to a manager’s style but they are still underperforming for one reason or another, then perhaps that is the time to be wary.