Man's best friend? If all they do is sleep, your cash won't grow

They're called 'dogs' – the funds that show consistently poor growth. Angelique Ruzicka reports on how to spot the danger signs and make your escape
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From dead cats that bounce to bulls and bears, the City loves its animal analogies. But for small private investors the only beast they need fear is the "dog".

This is the name for a fund that consistently underperforms its peers, is often expensive to buy into, and simply gives investors a rank bad deal.

Sadly, there are a lot of dogs around. Any fund manager can do worse than his rivals in the same sector, but usually the crème de la crème find a way to bounce back. Some managers, however, don't have the talent and produce consistently poor returns. When this happens, it's time to get out.

Dean McCarthy, director of adviser Cobalt Private Finance, makes the point bluntly: "If a fund has underperformed its benchmark index for each of the past three years, and by more than 10 per cent over the full three-year period, then you've got a dog on your hands – whatever a manager may say to the contrary."

Unfortunately, there are now more funds in the doghouse than ever before. Financial adviser Bestinvest pointed out in its annual 'Spot the Dog' survey that the number of funds earning this unwanted tag has increased from 52 in 2006 to 72 this year. The adviser acknowledged that more managers tend to underperform during periods of volatile markets, but it is clear too many managers are simply not good enough at their jobs.

A look at the performance tables in the UK All Companies sector reveals some big names in the doghouse. Fidelity, Martin Currie and New Star all feature in the bottom 10 funds for performance over 10 years. For example, the New Star Select Opportunities fund, ranked 290 out of 291, has grown by just 15.4 per cent over the past three years. This is less than a third of the average growth rate enjoyed by funds in its sector.

If you find you have invested in a dog fund, the solution is not to sit by idly and hope that the manager will suddenly turn things round. In most instances, experts recommend you sell immediately.

"If there is no indication of recovery, through either a change of investment philosophy or manager, it may be right to call time on the dog and move your money away," says Sean Scahill of wealth management firm Fisher Family Office.

The appointment of a new manager with an excellent track record, who might be expected to work some magic, could provide a reason for sticking around in the fund. "But even then you'd be tempted to move as the poor performance may have more to do with the investment strategy of the company than the skills of the manager," adds Mr McCarthy.

In order to find the best fund to replace the poorly performing dog, he advises taking several factors into account. "Look for consistent performance against the fund's peer sector over three- and five-year periods. Also look for good independent ratings such as those provided by Standard & Poor's and Morningstar. The manager's track record will also play a role."

Mr Scahill adds: "Depending on your appetite for investment risk, you should consider the volatility of the fund, which is the level of risk the manager is taking to provide returns."

As for moving money out of a dog, there are pitfalls to be wary of. A transfer between different funds run by the same company is relatively easy: the investment house will simply organise the switch for you.

If you decide to change to another investment manager, this will involve the liquidation of your assets and the transfer of funds by cheque to the new manager.

If you sell your funds outright, they could be liable to capital gains tax.

"Investors may also be advised to transfer their holdings to online fund supermarkets or discount brokers. These allow investors to monitor their portfolios, compare performance and more easily spot the dog," says Rebecca O'Keefe head of fund management at Interactive Investor, the financial services website.

Once the switch has been made, it's important to monitor your new fund's performance to make sure you don't end up with another dog. You may not have much time on your hands but if you dedicate around 10 minutes a month to reviewing your funds, that should be enough, explains Ms O'Keefe.

"You need to ensure that you recognise the signs of when the fund is starting to come off the boil. These signs include a prolonged period of underperformance and a change of manager. Even general under-performance in other funds from the fund management group might indicate that the 'house' policy is off."

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