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The number of UK-domiciled funds that consistently underperformed their relevant market index surged in 2023, as inflation and rising borrowing costs battered equity performance.
Some 151 funds underperformed over the past three years, a 170 per cent increase on mid-2023, according to the twice-yearly Spot the Dog report by investment platform Bestinvest, owned by wealth manager Evelyn Partners.
The value of assets held by underperforming funds rose by 106 per cent to £95.26bn.
It has been particularly hard for fund managers to beat markets consistently over the past three years, said Jason Hollands, managing director of Bestinvest. This is because of sharply divergent performance from different sectors as the world reopened from the pandemic, war arrived in Europe and “excitement about artificial intelligence driving extreme market concentration in a small cluster of mega-sized companies”, he said.
Bestinvest analysed UK domiciled and regulated open-ended investment companies (OEICs) and unit trusts. Both mostly invest in equities and are open to retail investors. A fund must have failed to beat its relevant benchmark over three consecutive 12-month periods and underperformed the benchmark by 5 per cent or more over three years ending December 31 2023.
In the latter half of 2023, funds which concentrate on the global sector were well represented among poorly performing funds, with 49 included, more than doubling since mid-2023’s total of 24.
Nearly half of badly performing funds in the global sector focus on sustainable investing, and did not therefore benefit from boosts to oil and gas-related share prices during the period. Many of these funds benchmark themselves against the MSCI World Index.
Over the past three years the MSCI World Energy Index has delivered a return of 125 per cent (including dividends), with the world economy coming out of pandemic lockdowns and Russia’s invasion of Ukraine causing oil and gas prices to skyrocket.
The number of UK funds featured in the survey rose from five to 34, holding £12bn of investors’ wealth. Ethical and sustainable funds feature prominently in the underperforming UK funds, due to their lack of exposure to the UK energy and commodities industries.
Baillie Gifford’s Global Discovery and Japanese Smaller Companies funds were the top and tenth worst performing funds overall. The value of £100 invested in the funds after three years is £47 and £60 respectively. The Scottish investment manager’s assets have dropped by nearly one-third to £226bn since the end of 2021.
Responding to the firm’s inclusion, James Budden, director of marketing and distribution at Baillie Gifford, said: “Despite a difficult couple of years when growth investing has been sharply out of favour, we are increasingly confident that many growth companies we currently own are resilient in terms of pricing power, sales growth, and operational leverage.
“Over the long term, share prices tend to follow fundamentals and recent operational progress has been excellent in many cases.”
Two funds managed by renowned fund managers Terry Smith and Nick Train made the Spot the Dog list for the first time in the category of worst performing funds by size.
Although Fundsmith Equity and WS Lindsell Train UK Equity funds have delivered returns ahead of their relevant indices over the long term, they are now underperforming by 14 and 19 per cent respectively over three years, with the value of £100 invested coming in at £118 and £111 after three years.
Fundsmith aims to invest in a concentrated portfolio of companies which generate a high return on capital on a long-term basis. It has had no exposure to energy over the past three years, and is not heavily invested in technology companies, opting for heavy exposure to consumer staples and healthcare.
Fundsmith said: “Our main UK competitor’s global fund underperformed ours by 16 per cent over the period chosen by Bestinvest but is not rated as a ‘dog’, which raises an obvious shortcoming of the methodology. We also note that Fundsmith Equity outperformed the average return delivered by funds in the IA global sector over the last three years yet many of funds with worse performance are not rated as ‘dogs’.
“As we have always said, a year is simply the time it takes for the Earth to revolve around the sun. We think that investors should judge our returns over the long term, and since inception the fund is up 596 per cent or 15.7 per cent on an annualised basis, net of fees, compared with 11.8 per cent for the benchmark MSCI World.”
Lindsell Train also invests with a long-term approach, looking for companies that consistently generate high levels of cash and have competitive advantages, such as strong branding, which means it leans towards beverages, personal goods and financial services. It also has no exposure to energy.
Lindsell Train declined to comment.
Bestinvest emphasised that the survey is not a “sell list” and said funds can go through weaker periods due to poor decision making, bad luck, instability or because its ethos or process has fallen out of fashion.
Hollands said: “When you invest in funds that screen out certain types of companies . . . this can result in significant differences in performance from the market benchmarks, leading to periods of both underperformance but outperformance too.”
