What to do if your fund is underperforming

Jason Baran – Insight Analyst (Investments)

While there are some technical aspects to measuring performance, which I covered in my article on how to measure manager performance, what is clear is that the role of luck can play a large part. In order to mitigate this we must choose an appropriate time horizon. For example, at Defaqto we use at an absolute minimum three years of performance data.

However, historic fund performance is only part of the story. As we are concerned about future returns, we need to check forward-looking indicators of how a fund may perform. Frequently these are of a more qualitative nature.

Qualitative aspects

We should recheck the strategy of the fund and perform some style analysis to see how the fund is investing. We can check this historically, for example by regressing funds' returns against value or growth-based indices, and we can assess the current allocations for their bias towards duration, price/earnings, price/book, dividend yield, etc.

For example, for a value-orientated fund we would expect the fund to have lower than average exposures to price/earnings and price/book. A fund not investing as per its investment objective is displaying ‘style drift’ away from its investment objective and gives good reason for the investor to replace the fund with a more reliable exposure.

Charges and fees

Beyond this, it is also worth checking the fund’s ongoing charge figure (OCF) and portfolio turnover. A high value of either amount can be damaging to an investor’s returns. The OCF can be compared against the peer group, while portfolio turnover is an absolute measure and should be appropriate for the fund’s objectives.

Note that portfolio turnover, and the associated underlying brokerage costs are not included as part of the OCF. So, a fund manager who claims to invest on a long-term view should have a portfolio turnover ratio of <30% if they are running the fund as advertised – 30% corresponds with a roughly three-year holding period, so a lower turnover rate implies a longer-term investment holding period, on average.

Before making the final decision to reallocate to another fund, we need to take into account transaction costs. Not all funds are available at the same expense on every platform, and in addition some funds can charge very punitive loading fees of up to 5% depending on the chosen fund platform.

Also, before investing in another fund with a similar objective an investor should take the opportunity to reassess the allocation. For example, is the investor’s overall asset allocation appropriate? Could this be an opportune time to rebalance the whole portfolio or change exposure to other fund sectors or assets? If a portfolio rebalance is due shortly anyway, there may be economy of scale savings when completing a full rebalance.

By running through these questions, an investor can ensure that they are updating their fund exposures when appropriate and not subjecting themselves to any undue costs.