To weed out potential bad apples in your personal relationships, you might look for certain red flags or warning signs: Being rude to waiters, “trash-talking” a former partner, or an unwillingness to compromise.
Likewise, there are red flags to watch for in funds. And it’s worth checking your holdings to see if any appear.
Many investors choose active managers for at least some of their holdings, for their potential to perform better than stock market indices. But active fund managers are only human, so mistakes can be made, and new risks can emerge.
One fund under scrutiny now is Jupiter UK Mid Cap, which aims to grow by investing mainly in medium-sized UK companies. The fund has been trying to sell its large holding in Starling Bank, the unlisted financial institution, which represents 5.2 per cent of the portfolio.
That’s within the rules which cap open-ended funds’ exposure to unlisted securities at 10 per cent of assets. But funds can struggle to raise cash from these illiquid investments if too many investors want to sell. And, like many UK equity funds, the fund has also seen a steady stream of outflows over the past year.
Enter Fidelity International, which is banning customers of its Personal Investing platform from new investments in the Jupiter UK Mid Cap fund, while not preventing them from selling holdings in the fund. It’s an unusual move — I’d like to have seen more explanation from Fidelity other than “we believe the decision is in the best interest of our clients”. Jupiter declined to comment.
But I do applaud caution around open-ended funds that offer investors daily access to their money, while holding unlisted assets.
It’s horrible to be an investor in a fund that has to close the exit doors. Investors in Neil Woodford’s Equity Income fund are still waiting for closure after the 2019 scandal, which highlighted the perils of liquidity mismatches.
For this reason, I prefer investment trusts for holding exposure to unlisted companies, as the trust shares trade separately from the underlying assets. The private equity sector of the Association of Investment Companies is the place to look.
But returning to red flags, it’s frustrating that open-ended funds typically only publish their top 10 holdings: unlisted stocks usually don’t appear as they are smaller holdings. However, making sure you understand the top 10 holdings is a decent start for your due diligence.
Other potential warning signs to look for on the fact sheet are a change in fund manager or a drift away from the investment style that the fund had when you bought it. Managers can venture into parts of the market where they have unproven records.
Also watch out for funds potentially becoming a victim of their own success — too big to follow their remit properly — this particularly applies to smaller company funds, where too much asset gathering can force managers to buy larger companies.
In January 2022, Interactive Investor, the investment platform, dropped the CFP SDL UK Buffettology fund from its recommended investments due to concerns about the size of assets — the fund’s success had come from investments in smaller companies. The fund fell 23 per cent during 2022, with manager Keith Ashworth-Lord saying “it is the derating of the great companies we own that has caused the damage this year rather than anything wrong with the businesses themselves”.
Even if the manager is a “star” name, with a good past record, you’ll also need to review performance — I suggest at least once or twice a year. With most funds losing money in 2022, the reasons are obvious.
In relationships, we often convince ourselves we can make any situation better. And the same goes for funds. We choose them because they look attractive and have a compelling story. But we find it hard to ditch them.
Bestinvest’s twice yearly Spot the Dog survey is a good way to weed out the worst offenders. To make it on to the list, a fund must have underperformed compared with the market it invests in by 5 per cent or more over a three-year period.
But I’d start looking for alternatives after two years of a fund underperforming its peers or benchmark index.
Meanwhile, if a loved one apologises, we’re inclined to listen sympathetically. Perhaps this is why several fund managers have issued public apologies for poor performance.
Carl Stick’s Rathbone Income fund was one of the worst performers among UK funds in 2008, losing 34 per cent of its value. Reflecting on the credit crunch, Stick said: “I’m sorry we lost that money, but you learn by experience.” After changing his strategy to take fewer risks, Stick delivered improved performance.
By contrast, in 2014, Tom Dobell, manager of the M&G Recovery fund, saw his good performance take a turn for the worse. He issued an apology to investors: “We are very aware the fund has lagged the market in recent times, and I am sorry for that.” But he also insisted he would not change his investment style and the underperformance continued. Dobell stepped down from the fund and left M&G at the end of 2020.
Just this week, Terry Smith, manager of Fundsmith Equity, issued a lengthy letter to investors, to explain his underperformance, signing off with a quote from Winston Churchill: “If you are going through hell, keep going.”
Hearing out the managers is important. And investment vehicles aren’t immune to reverses. Many patient investors have kept faith with Scottish Mortgage Investment Trust, which has seen its share price drop 50 per cent since November 2021, after manager Tom Slater said: “We are redoubling our efforts to find new investments that can adapt to difficult economic conditions.”
But an explanation or apology is no guarantee of what may come. If your fund has chronically underperformed, I wouldn’t bother waiting for one.
Finally, in the search for red flags, I’m sure you don’t want to be a full-time analyst. A good shortcut is to look at the investment platforms’ rated lists, which include popular funds held by investors. Hargreaves Lansdown, Interactive Investor and AJ Bell all publish removals on their websites.
Despite improvements to governance of these lists, they are not fail-safe — is anything? But It’s worth looking at what funds they ditch to check that these are not in your portfolio.
A red flag can sometimes introduce a tricky decision — to stick or switch. In the case of Jupiter Mid Cap Fund, analysts at Morningstar say the outflows have arguably made it a more manageable size for a UK mid cap fund. The fund size has gone from around assets under management of £3bn to £1bn, which in the long term could be a positive.
But if you can’t make up your mind, I’d err on the side of caution. The classic break-up consolation of “there are plenty more fish in the sea” applies — with thousands of active funds. And you can always check out passive alternatives too. Funds that track stock market indices will not have the potential to outperform, but they will be cheaper and less prone to human error.
Moira O’Neill is a freelance money and investment writer. Twitter: @MoiraONeill, Instagram @MoiraOnMoney, email: moira.o’[email protected].