With investors holding on to funds for just three years on average, managers have a short window to impress clients.
But investors who make decisions based on the prior three-year performance may be buying or selling funds at the wrong time.
The trend towards shorter holding periods was highlighted most recently by the Investment Association, the UK asset manager trade body, which revealed that the average holding period for a fund had fallen from around eight years in 1997 to three years in 2016.
Average holding period of retail investors 1997-2016
Source: Investment Association
There are a number of reasons behind the trend from an eight-year holding period to three years, the trade body noted.
It highlighted improved platform technology, increased investor engagement in portfolios, and increase in independent research over the past two decades.
However, while holding periods may have fallen over the last 20 years, investors could be hurting their own portfolios by having such a short-term focus.
Research Affiliates, the investment consultancy, highlighted a similar trend among institutional investors, noting they too often sell funds once they have underperformed the market for two-to-three years.
“Underperforming strategies are often newly cheap and might well be better candidates for new assets, not for termination,” noted authors Rob Arnott, Vitali Kalesnik, and Lillian Wu.
“If a manager has performed brilliantly and the manager’s assets are at record-high valuations relative to the market, investors should arguably redeem, not invest more.
“If a manager has performed badly and the manager’s assets are at an exceptionally cheap relative valuation, investors should seriously consider topping up, rather than firing the manager.
They added: “We are not suggesting that past performance is irrelevant, only that it’s a terrible predictor of future prospects. Likewise, past success is not always a sell signal.”
Below, FE Trustnet considers three-year and eight-year performance in the IA UK All Companies sector – the largest in the Investment Association universe – and how funds have performed relative to the FTSE All Share index.
For the three years to last month-end, the average IA UK All Companies fund has returned 25.72 per cent compared with a 24.76 per cent return for the FTSE All-Share index, which represents 98-99 per cent of UK market capitalisation, according to data from FE Analytics.
Performance of sector vs index over 3yrs
Source: FE Analytics
Over eight years in comparison, the average sector fund has risen by 119.89 per cent compared with 113.85 per cent return for the index.
Of course, it should be noted that the sector’s funds include a range of UK equity strategies with different investment objectives and processes. However, some investors might be forgiven for wondering if they would be better off in a passive strategy.
Examining the underperformers from the IA UK All Companies sector in the three-year period to 31 August 2014 and their most recent three-year performance to 31 August 2017 throws up some interesting results.
Of the 35 funds that recorded a worse return than the FTSE All Share’s gain of 44.53 per cent for the first period, just 13 outperformed the index return of 24.76 per cent in the second period.
Conversely, over eight years, 123 funds, or 72 per cent, from the sector have outperformed the index of 170 funds with a long-enough track record. However, this could be attributed to unsuccessful and smaller funds being closed over time, weeding out some of the poorer performers and distorting the average fund return.
For comparison, of 57 funds that were among the sector’s bottom quartile in the three years to 31 December 2013 just seven had moved to top quartile status, a further seven (including one tracker fund) were second quartile in the following three-year period.
Looking at more recent performance, below, we have considered the returns of some of the funds that under- and out-performed the FTSE All Share index over the three-year period to 31 December 2016 and how they have performed so far this year.
Indeed, of the 152 funds that underperformed the FTSE All-Share index in the three-year period between 2014-2016, 61 have turned around performance to outperform the index in the year to 31 August.
The best performer in the latter period was the Elite Webb Capital Smaller Companies Income & Growth fund, managed by former Unicorn Asset Management founder and chief executive Peter Webb.
The fund has returned 24.08 per cent this year as it benefits from a strong year for the small-cap strategy, as the below chart shows. (It should be noted that the fund has no given benchmark.)
Performance of fund vs sector & FTSE All Share YTD
Source: FE Analytics
“The fund has performed very well during recent times and our underlying investments continue to enjoy buoyant trading,” noted Webb in the latest fund factsheet. “Your manager remains open to new ideas but believes that the current portfolio mix of outstanding international companies and specialist domestic based opportunities is ideal for current markets.”
The Webb Capital fund was closely followed by the £127m Standard Life Investments UK Opportunities managed by Abby Glennie, which has risen by 22.32 per cent in the year to 31 August.
Both funds are among 11 that were bottom quartile during the 2014-2016 period but have turned in a top quartile performance during 2017.
FE Analytics data also revealed that of the 95 funds that outperformed the index between 2014-2016, 66 have continued to outperform the index in 2017.
Yet, if investors had sold out of a poor performing fund over eight years at the end of 2016, they may have been justified.
Of 84 funds that failed to outperform the index over the eight-year period, 57 – or 67 per cent – have so far failed to outperform the index in the year to 31 August.
At the other end of the performance table, 128 funds outperformed the index at the end of 2016 with 79, or 61.7 per cent, outperforming again in 2017.
While it is difficult to assess whether a three-year or an eight-year track record is more important, an investor’s decision is likely to depend on a range of factors.
However, it should be noted that generating better than index returns over consistent rolling three-year periods can be quite difficult. Data from FE Analytics revealed that in rolling three-year periods to last year-end, just five have managed to outperform the FTSE All Share over the long term.
Just five have managed the feat over 10 consecutive rolling three-year periods, going back to the 2005-2007 period: Aviva Investors UK Equity, Majedie UK Equity, Majedie UK Focus, Threadneedle UK, and Threadneedle UK Mid 250.