FSA attacked for suggesting fund chiefs rely on luck

City watchdog warns past performance is not a good guide for choosing an investment fund
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The Independent Online

Successful stock picking – is it an art, a science or a matter of luck? The Financial Services Authority has revived this hoary debate by suggesting that the best professional investors are probably just plain lucky. Not surprisingly, many pension fund managers are furious.

The row dates back to August when the FSA published research showing that an investment fund's past performance is a useless way of gauging its likely future returns. Now the City watchdog has launched an online service for comparing ISAs through tables which exclude data on past performance and instead focus on charges. "Take past performance claims with a pinch of salt. Nearly all companies can select a short run of figures which make them look better than their competitors," counsels the FSA website.

Reliable comparative information about performance is hard to produce, and would not necessarily be useful, the FSA argues. "What we are providing are robust, objective indicators. We have that for the costs of getting in and out of a fund," says an FSA spokesman. "We're looking at the feasibility of developing a standardised indicator. If we can develop it – and it's a very big if – then we'll reconsider our position. There's a philosophical issue here. The evidence shows that where repeat performance exists, it's a very small effect."

Assessing the performance of a fund against the market is tricky. A fund may have several different portfolio managers over a period of time, or have a certain attitude towards risk. It is also difficult to know over what period to assess a fund, since almost every fund manager can point to one year when they have handsomely beaten the market.

Alan Wilcock, director of research at CAPS, which compiles quarterly pension fund performance tables, says studies repeatedly show a "fund manager effect" although it is hard to quantify. "You need to make a lot of observations of the data to be able to draw any inferences, and without that you can't say there's a statistical effect," he said.

Amid the chaos, it is easy to make bold claims for a fund's performance. Regulations permit funds to highlight returns over any chosen time frame in the main body of an advertisement, so long as performance over five years appears in the small print. One ruse is to flag up a year of outstanding performance, and note in the small print that the fund is a particularly high risk. Some niche funds have advertised their outperformance against inappropriate peers, while other companies have constructed hypothetical tables extrapolating recent performance back over the last five years.

While the FSA is keen to protect consumers from being misled, fund managers fear that the blanket rejection of performance-related data makes them resemble gamblers. "What other measure would you use apart from past performance?" asks Alan Miller, chief investment officer at New Star Asset Management. "Obviously a six-month track record isn't much to go on, but over three years it's meaningful."

A spokesman for Fidelity Investments says: "Past performance should never be taken in isolation, but it is absolutely key. The FSA's stance is fine as regards absolute past performance, but not as regards relative outperformance."

Ann McMeehan of the Association of Unit Trusts and Investment Funds says: "It would be absurd to say a football player's goal-scoring record is no guide to future performance, but the FSA questions applying that to fund management because it can't be proven. It implies it all comes down to luck."

One investment director at a major European asset manager says: "Charges is a terrible way of selecting funds. If a fund is cheap, it's probably because the company has put its worst staff on the job. Retail investors should find out about the past performance and riskiness of fund managers by going to a financial adviser."

Still, there are voices of dissent, most notably David Rough, outgoing head of investment at Legal & General, who has argued that tracker funds should be central to any investment strategy.

Who's right? The FSA's advice is based on studies by WM Company, the performance measurement specialist. It has found that the best-performing fund managers in a particular period are no more likely to come top in the following period, although the worst performers are likely to be consistently bad. Eric Lambert, WM's head of research consultancy, says the key to past performance is identifying consistency across three-year rolling periods and setting outperformance in context. "You have to look at the way in which a return has been delivered. If a fund manager has doubled his returns but taken twice the risk, then he hasn't added anything. Fund managers usually ride a cycle. Few are clever enough to reverse their strategy before the cycle turns."

Still, fund managers claim to possess a skill. But given they all have access to the same information, what affords them competitive advantage? Fidelity's Anthony Bolton is among the UK's best known "star" fund managers. His Specialist Situations fund has grown by 5,700 per cent over the last 22 years, against market growth of 1,949 per cent. "Anthony has a tremendous instinct," says a colleague. "He looks at situations others avoid. He has 55 analysts researching companies, which means he can specialise in stock picking."

New Star's Mr Miller says: "It simply comes down to the common sense of the fund manager. Good managers are often those who go against the fashion."

One senior European fund manager says success comes down to "years of experience and a lot of research".

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