Lessons from the last decade of flop funds

With £9bn of UK cash stuck in 'dogs', it's vital investors do their homework, says Rob Griffin

Fund managers remain optimistic about the outlook for the US (Getty Images)

Fund management houses may be very quick to crow about how well their flagship funds have performed and how much money has been made for investors, but they're not quite so keen to discuss those which have failed to deliver the goods.

So it's only by analysing the names at the wrong end of the performance tables that you can find out which portfolios have plunged into negative territory, examine the reasons why their values might have slumped, and evaluate their future prospects.

We teamed up with analysts from Morningstar to discover the worst-performing Investment Management Association (IMA) sectors and individual funds over the past decade – and the findings make worrying reading. While the stand-out funds have returned almost 500 per cent, the worst have shed around 30 per cent.

The world over the past decade

It's certainly been a tumultuous 10 years. In early 2002, the world was still reeling from the bursting of the technology bubble, which had seen entrepreneurs with even the vaguest web-related ideas handed millions of pounds.

Since then, economic and political problems have made it difficult for even experienced fund managers to generate strong, sustainable returns, says Darius McDermott, managing director of Chelsea Financial Services. "There have been a number of serious market corrections," he says. "We have gone from the aftermath of the peak of the tech-fuelled valuation cycle to the financial crisis of 2008 and associated terrible market conditions."

Which sectors have done the worst?

The good news is that all the IMA sectors, on average, have made money in the past decade, according to the Morningstar data, compiled up to 23 March 2012. However, the worst have only increased in value by between 20 per cent and 30 per cent – hardly exceptional after 10 years of investment.

Bottom of the pile comes the IMA North America sector, whose 43 funds are only up, on average, 20.09 per cent, just ahead of IMA Japan's 33 funds which have enjoyed a pretty modest average uplift of 21.23 per cent. The next three worst-performing sectors are IMA Short Term Money Market (25.43 per cent); IMA Property (26.98 per cent); and IMA Money Market (27.46 per cent). It will surprise many people to see North America as one of the worst-performing sectors but observers point to currency issues, the financial crisis and a hangover from the tech bubble bursting as reasons.

Indeed, fund managers in this area remain optimistic about the outlook for the US.

For example, Aris Vatis, who runs the Fidelity American Fund, recently insisted the case for US equities was compelling because of the region remaining the location of choice for leading brands and technology firms.

Japan, meanwhile, has been a difficult place to invest for many years – and that remains the case, according to Mr McDermott. "It had its boom in the 1980s and the market peaked around 1990, since when it's been in a downward spiral," he says. "There have been periods of uplift but the reality is that the index has gone down a long way over that period of time."

Elsewhere, Patrick Connolly, head of communications at AWD Chase de Vere, believes there are reasons Money Market funds have been among the most disappointing. "In periods when real assets are rising in value, as they have done over the past decade, money market and cash funds will also be comparatively poor performers," he explains. "Their performance has been hindered by the low interest rate environment, which means returns are low."

Property funds have also been left reeling from extreme sentiment swings, which culminated in the asset class being overbought during 2006. "It then suffered big losses in 2007 and 2008 as investors headed for the exit door," says Mr Connolly.

"Sentiment remains fairly negative and so it is unlikely that we willsee a big upturn in property prices any time soon."

What funds have performed badly?

Of the 1,015 funds analysed for us by Morningstar, the average increase they achieved over the past year was 77.07 per cent. However, although some have enjoyed massive gains, the worst performers have suffered double-digit losses which will have been devastating for investors.

The Manek Growth fund has been the worst with a loss of 33.12 per cent. It is followed by Invesco Global Technology, down 23.66 per cent; and IP US Equity, which has shrunk 22.37 per cent. Next is Kames American Equity, off 17.33 per cent; and Premier Castlefield UK Alpha General, down 15.63 per cent.

Chelsea's Darius McDermott is not a fan of Manek Growth.

"This is a peculiar fund that has short periods of very good outperformance but much longer periods of substantial, deeper, underperformance," he says. "It's also very difficult to find out much about what they're investing in and it's certainly one to avoid."

Elsewhere, the Invesco Perpetual US Equity fund has suffered great turbulence over the past decade – and this situation has not been helped by the fact it has had six different managers in this time, points out Patrick Connolly at AWD Chase de Vere.

"The fund has underperformed significantly in both rising and falling markets leaving it some way behind much of the competition," he says. "This poor performance has been because of Invesco Perpetual's poor stock-picking and sector bets and a lack of research resources in the US. However, performance has improved a bit in the past couple of years."

Where should people have invested?

The biggest themes over the past decade have been the growth of the emerging markets and the urbanisation of China, according to Mr McDermott, who points out that most funds with a connection to this area will have done very well.

"Even though they have been more volatile it's been a good decade for emerging market equities and it's been an unbelievable time for some of the specialist resources funds," he says.

"These have played directly into the growth in the emerging markets, and in particular, the urbanisation in China, which have been two of the most dominant recent themes."

This view is borne out by the figures. Anyone that invested in the IMA China/Greater China sector will probably be smiling now as the average fund has risen by 215.39 per cent over the past 10 years, according to the Morningstar data.

IMA Global Emerging Markets is next with 213.32 per cent uplift, followed by the 186.27 rise for IMA Specialist. The 169.68 per cent rise for IMA Asia Pacific ex-Japan is enough to put that sector into fourth, just ahead of IMA European Smaller Companies, which has gone up 146.33 per cent.

These strong sector themes are reflected in the list of best-performing funds over the past decade, which is dominated by those with exposure to emerging markets and resources.

Their success has been because of strong growth in these regions, currency movements, and inspired stock picking

The stand-out performer over the period has been the JPM Natural Resources which has recorded a remarkable 490.82 per cent return.

However, the next six funds have each delivered returns in excess of 400 per cent, which is a tremendous result.

Conclusion

So what can we learn from this data? Well, it's certainly vital to spend time selecting the right funds and managers – especially when you consider the gap between the best and worst-performing portfolios over the past decade was more than 520 per cent.

It was a point made by the "Spot the Dog" report, published by Bestinvest, which highlighted that £9.24bn of UK investors' money is languishing in so-called dog funds. It revealed that investors had paid £133m in annual management charges over the past 12 months for the privilege of having their funds managed by the industry's worst performers. Taken over the three years the report was based on, this equated to nearly £400m in charges.

You need to look at the best-performing managers within each sector and have a decent investment time horizon of at least five years, according to Geoff Penrice, a financial adviser with Honister Partners, who expects to see market rallies as soon as economic issues are resolved.

"I would consider investing in funds which can benefit from the growth of developing countries, such as M&G Global Basics," he says. "Remember that trying to time the market is very difficult and people tend to get it wrong more than they get it right."

At a glance: Where bets have really come unstuck

Worst-performing sectors

IMA North America: 20.09 per cent

IMA Japan: 21.23 per cent

IMA Short Term Money Market: 25.43 per cent

IMA Property: 26.98 per cent

IMA Money Market: 27.46 per cent

Worst-performing funds

Manek Growth:-33.12 per cent

Invesco Global Technology: -23.66 per cent

IP US Equity: -22.37 per cent

Kames American Equity: -17.33 per cent

Premier Castlefield UK Alpha Gen:-15.63 per cent