The phrase ‘we live in interesting times’ is one that is probably overused but over the last 18 months anyone using it has without doubt had reasonable cause. With lives turned upside down for months on end, it has been a tumultuous period for everyone and that’s before we think about the impact on the investment landscape.
Monday 9 November will be remembered as a pivotal day in the fight against COVID, as news of a successful vaccine trial sent markets into a frenzy of activity, with previously battered stocks soaring and those that had done well out of the changes to our lives lagging after their previous outperformance. Now things have settled a little, it’s interesting to look at fund flows around particular investment funds to understand investor behaviour.
The ideal scenario when it comes to investing is to ‘buy low and sell high’ and this statement shouldn’t come as a surprise to anybody but, when observing investor behaviour over the past 18 months, the reality continues to be somewhat different. Indeed, many investors seem to be risking the very opposite, namely ‘buying high and selling low’, through the act of chasing the most recent performance story.
Let’s look at Schroder Global Recovery as an example. This is a fund that we rate highly, managed by an experienced team which follows a deep value style. Needless to say though, with that investment approach, relative performance was very poor and, from launch in October 2015 to Friday 6 November 2020, it was 33% behind the MSCI World index. Some would have no doubt described it as a ‘dog’ fund, while the fund was relatively small at around £250 million and failing to gain much investor interest. However, with value investing getting the proverbial shot in the arm from the vaccine announcement, the fund subsequently outperformed the index by 25% from 6 November to 28 February 2021. This great performance comes as no surprise to us given the team’s pedigree in value investing and we were happy to have the fund as part of our Fundamentals list all the way through the ‘bad’ and ‘good’ performance. However, it’s interesting to then look at recent fund flow as – in the past two months, after the recovery in performance – investors have piled in more than they had in the preceding five years, with £350 million of net sales vs £333 million. A classic case of momentum chasing and now the fund has grown to just shy of £1 billion in size.
It doesn’t just happen to money flowing in, though: we see similar trends after funds have a tough period. This time, let’s use another fund we have on the Fundamentals list and in our MPS, the Troy Trojan Income fund. This is a fund that focuses on high quality, defensive stocks and navigated last year’s Q1 sell-off very well, outperforming the UK market by 8.5% in Q1 2020 and in the following four months saw £499 million of net flow into the fund. However, after the vaccine news, the fund has, unsurprisingly in our view, underperformed the market and trailed by 10% between 6 November 2020 to the end of February 2021. We understand why the fund has underperformed; it’s in line with our expectations and, frankly, if it had outperformed, we would have been asking the fund managers some serious questions. But, when we look at other investors’ behaviour, March and April saw a combined £455 million flow out of the fund. Once again, right after the fund has had a period of underperformance.
There are countless other examples that could be used to illustrate this point over long periods of time but all will show the same issue, namely that money flows into funds after they have had a particularly strong period of performance and out of funds after a particularly weak period rather than before they have it. It’s this behavioural trap that so many investors, both amateur and professional, fall into. It’s far easier to buy something after it has done well and much easier to justify selling something after it has done badly. The trouble is that unless you have a crystal ball about what’s going to happen in the future, there is a huge risk that investors have simply once again fallen for the ‘buy high, sell low’ trap.
In our Investment Team, we are honest enough with ourselves to say that we don’t know what the markets will do in the short term and therefore we don’t try and predict it. As we have seen over the past 12 months, shifts in style can be fast and dramatic and getting caught on the wrong side of them can be costly. Those investors piling into value funds after they’ve already bounced are essentially looking to correct an underweight position just as those jumping out of high-quality funds after they’ve underperformed are correcting an overweight position.
In our MPS, we take a different approach by running a style-diversified portfolio at all times. Given we don’t know when styles will change, we prefer to have exposure to growth, value and quality throughout the cycle as this acts as a smoothing mechanism in times of rotation and volatility. Using our UK allocation as an example, our holding in Troy Trojan Income came into its own last year during the sell-off while our Man GLG Undervalued Assets holding was weak but, when the vaccine news came, these positions flipped and Man GLG contributed strongly to performance. This style- diversified approach also sits comfortably with our rebalancing approach that allows a top-slicing of the winners and a topping-up of the underperformers. Over time, this topping and tailing should be additive to performance across a market cycle.
Ultimately, this is a story about portfolio construction and understanding how different managers invest so that the temptation to chase performance is resisted. The real world data shows just how many investors fall into those behavioural traps, turning their portfolios into one big game of momentum kiss chase and, each time it goes wrong, investors turn round and blame the fund manager for doing a bad job. Taking a style-diversified approach to portfolio construction removes the urge to react to events, while bringing natural diversification that should over time result in an improved risk-adjusted outcome.
Figures sourced from Morningstar.
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