Surge in underperforming funds on ‘Spot the Dog’ list

The amount of UK savers’ cash languishing in underperforming funds has jumped to more than £45bn, according to a report by Bestinvest, which warns that more turbulent markets will increase the pressure on active managers to prove their worth.

The surge in stock markets following the Covid crash saw a steady drop in the number of “dog” funds that underperformed the broader market sector in the investment provider’s twice-yearly scorecard.

But that trend reversed in the most recent report with the number of long-term underperforming funds creeping up from 77 last summer to 86 at the end of 2021, when markets began to falter, while the amount of cash in laggard funds ticked up by 54 per cent.

Since then, markets have suffered a harsh sell-off, which has already hit some well-known stockpickers, and which could spell trouble for active managers who enjoyed relatively clear sailing during a benign period of rising markets.

“Rising markets have lifted all ships,” said Jason Hollands, managing director at Bestinvest. “If we move into a more challenging patch for the markets, the difference between the better managers and the also-rans could actually mean the difference between real gains and losses.” 

“In recent years, it has been tougher for investors to identify weak funds, with low interest rates and central bank money-printing programmes pushing share prices higher. Most funds investing in equities have generated gains irrespective of the skill of their managers,” he added.

The merits of investing in actively managed funds has been under scrutiny in recent years given the rising popularity of low-cost passive investment options, which simply track the performance of the market. Stockpickers who aim to deliver superior returns have faced more calls to defend their record and higher fees.

Investment companies such as Vanguard, which have tried to woo investors into their passive strategies, argue that these low-cost options are a better bet for most people. “Consistently outperforming the market, over the long term, is very difficult,” said Jan-Carl Plagge, head of active-passive portfolio research for Vanguard in Europe.

Plagge said investors who pick active managers should be careful about changing their selections too quickly, citing research which shows that among funds that outperformed over 10 years, nine in 10 had at least a three-year spell of lagging returns.

The report from Bestinvest, which screens 897 UK-based mutual funds with a combined value of £660bn, names “dog” funds that have performed worse than the broader market in which they invest over each of the past three years, and which have underperformed by at least 5 per cent over that period.

Several major fund managers have billions of dollars of their clients’ money in these underperforming funds. A number of Halifax and Scottish Widows-branded funds managed by Schroders have a combined £8.6bn in flagging strategies, while the UK’s largest wealth manager, St James’s Place, has £5.7bn sitting in funds on the list.

“£45bn is a lot of savings that could be working harder for investors rather than rewarding fund companies with juicy fees,” said Hollands.

Lloyds Banking Group, which owns the Halifax and Scottish Widows brands, said the funds shouldn’t be judged solely on recent performance. “We believe the long-term outlook means this investment style is still appropriate for our customers’ investments,” it said. Schroders said it regularly reviews fund performance to see if “action is required to improve outcomes for our investors”.

St James’s Place said it had taken steps to improve performance at a number of funds and that its average customer had seen strong returns over the past decade by investing in a combination of funds.

At the end of 2021, the largest source of “dog” funds were those mandates that tilt away from US tech stocks, which raced higher throughout most of 2021. Managers who focus on income, or who tried to balance exposure to the US with other regions, frequently fell behind benchmarks that were heavily influenced by rising American tech stocks.

However, markets have started 2022 in a different mood, with US tech shares tumbling by around 10 per cent. “In six months time, if current market shifts play out, you might see a little bit of a changing of the guard,” Hollands said.