Only a third of UK high net worth investors would hold an underperforming fund for more than 12 months and more than a quarter will sell out after just three months, according to a survey from Legg Mason. 
The study took the answers of approximately 5,000 investors spread across 19 different countries and also found that the majority 44 per cent would sell an underperforming fund in less than half a year.
This data opposes the guidance of many investment professionals, who believe that in order to generate strong returns, investors must have at least a medium to long-term time horizon when building their portfolios and should understand that it is common for funds to endure bouts of underperformance as styles fall in and out of favour.
UK investors between the ages of 18 and 39 had even shorter time horizons, however, with just 14 per cent of those surveyed willing to hold an underperforming fund for more than 12 months. Some 21 per cent of global peers of the same age would hold an underperforming investment for longer than a year though, suggesting that millennials on our home turf are particularly impatient when it comes to the performance of their portfolios.
Across all 19 countries surveyed though, the most common time frame for millennials to hold lacklustre funds was between just one and three months.
Interestingly, though, investors surveyed seemed less deterred by market volatility as, while older investors would be willing to hold an individual stock to 16.7 per cent declines, millennials would not re-evaluate their exposure to a holding until a fall of 20.3 per cent on average and would actually sell a position at a fall of at an average of 23.3 per cent.
“The survey reveals an interesting dichotomy between investors’ attitude to market falls and their approach to funds that underperform in the short-to-medium term. On one hand, investors seem willing to tolerate reasonably steep market declines before re-evaluating their equity exposure, but only a third will give a fund a year to turn performance around, and 44 per cent in just six months,” Legg Mason’s Adam Gent said.
“It could be argued that this is insufficient time given that many funds have rolling return targets that stretch over years not months, which perhaps emphasises how important it is that investors understand what they hold and under what conditions they are likely to underperform.”
Joshua McCathy, portfolio manager at BRI Wealth Management, says that when a fund the firm holds has been underperforming, it will be discussed at length as part of a weekly meeting within the portfolio management team.
He points out that the reason for the fund’s underperformance is paramount, explaining that poor performance could be caused by bad stock selection from the fund manager or simply because their investment style has temporarily fallen out of favour.
“We don’t tend to take quick decisions on performance unless we see something going on with flows which would compromise our position in the fund,” he explained.
“We do quite a bit of due diligence before we decide to sell out because, if we’ve gone into the fund in the first place, it’s because we believe in the management and the process. We would basically do a re-cap.”
An example of an underperforming fund that the firm holds, according to the portfolio manager, is Schroder Global Equity Income.
The £126m fund has been headed up by Ian Kelly and Jamie Lowry since 2013 and, over this time frame, it has outperformed its average peer by 1.94 per cent with a total return of 13.56 per cent.
However, the fund is in the bottom quartile over one, three and six months and is in the third quartile over the last year, having made a loss of 4.11 per cent compared to its sector average’s loss of 1.82 per cent.
Performance of fund vs sector over 1yr
Source: FE Analytics
“We still like as a fund but, over the last two years, its themes have underperformed as growth funds have done better,” McCathy said.
“We still like the manager, we still like the process and we still like some of the underlying holdings. We met the manager not too long ago and it’s something we think will come back.”
Ryan Hughes, fund manager at Apollo Multi Asset Management, agrees that it depends on the reason for a fund’s underperformance and says that the key before making any investment is to understand the manager’s process and philosophy.
He says that, if a manager underperforms during times when their style is out of favour, it means that they are in fact performing in-line with expectations.
“The problem comes of course when managers are in an environment where their process should be working and it’s not,” the manager explained.
“It depends on the fund [when you sell], there is no one set of scenarios where you have a trigger point. It’s a case of going to see the manager and doing a lot of analysis as to where that underperformance is coming from – maybe they’ve only got one or two stock calls wrong and that’s dominating performance or maybe it’s a broader asset allocation call that’s gone wrong.”
“Underperformance is not necessarily the issue, it’s when, why and how that are the important questions to ask and, therefore, if we get the right answers for those questions, we can be very patient, but if any of those areas start flagging up major issues then at times we will need to react very quickly.”
An example of an underperforming fund that Hughes holds is Natixis H2O MultiReturns, which is managed by Vincent Chailley and Jeremy Touboul.
The absolute return strategy was launched in 2013 and aims to outperform the GBP LIBOR rate by 4 per cent per annum over rolling three-year periods. While the fund has performed well since launch having provided a positive return of 29.8 per cent compared to its benchmark’s return of 1.29 per cent, its performance has dropped year-to-date.
Since the start of 2016, it has provided a loss of 8.12 per cent while its benchmark has provided a positive return of 0.19 per cent.
Performance of fund vs benchmark in 2016
Source: FE Analytics
“The fund has a global macro approach where they’re quite aggressive in their positioning and quite active in the way they manage their money, but it’s underperforming in our eyes as we’d hope it to adopt an absolute return approach and it’s losing money,” Hughes said.
“What have we done about that? We’ve had a couple of conference calls with the managers regarding positioning, we met them again last week and talked through their positioning, their thought process, their rationale for holding each of their positions, and we understand how they’re positioned, why they think like that and what the scenarios are where they will do well or badly.”
“That’s given us a lot of comfort with that position so we’re happy to carry on holding it despite the fact it’s underperforming, because we understand which set of scenarios need to happen before they start doing well again.”
