Julian Robertson explains the dangers of clustered fund launches.
The old adage that managed funds launched in a short space of time and/or pursuing specific themes can herald poor future returns has a great deal of validity.
Technology is the classic example of the phenomenon of trend-following fund launches. A raft of technology-related funds was launched around the turn of last century as fund managers sought to cash in on the internet mania.
There were 28 such fund launches in Australia between September 1999 and December 2001. The NASDAQ Composite Index, a broad barometer of technology companies, peaked in March 2000, after a 10-fold increase over the previous decade. Only five of these 28 funds remain.
Table 1 shows the various performance characteristics of the funds in this segment. It does not make pretty reading.
The annualised average loss of the terminated funds was -17.70 percent, and on average the terminated funds trailed the category average by 80 basis points per annum.
Tellingly, the average annual return of the category was 3 percent after the funds were terminated. This indicates that investors invested at exactly the wrong moment, crystallised losses, and then missed out on the subsequent recovery.
Other popular types of fund launches have included concentrated, long/short, mortgages, emerging markets, resources, and infrastructure vehicles.
We’ve also looked at the performance of concentrated Australian share funds relative to the provider’s flagship offerings. These concentrated vehicles have been steadily launched throughout the past decade.
The concentrated versions, generally marketed as higher-alpha strategies, have generally under-performed their more diversified and longer-standing siblings.
For example, over the three years to 30 April 2013, six of the nine concentrated strategies fared worse than their more diversified counterparts.
And given the more focused nature of these strategies, it’s little surprise that they are nearly always more risky than the flagship option. This has translated into poorer risk-adjusted results, although the experience has not been as disastrous as was the case with the technology funds.
Given these examples of categories where ‘flavour of the month’ funds have subsequently underperformed, we suggest maintaining a healthy degree of scepticism.
These funds might seem great in theory, offer apparently rational propositions, and seem to play a potentially valid role in an investment portfolio, but they’re generally preceded by periods of strong outperformance, and investment timing decisions are often sub-optimal.
Emerging markets and resources funds are good examples of this. While we consider emerging markets equities to be a viable long-term asset class, again, there was a spate of fund launches in 2007 and 2008.
The performance of the emerging markets up to that time meant that this was an easy sell, but returns immediately after these launches have been underwhelming.
Resource fund launches are another good example of this phenomenon. The majority of those currently in existence were launched between March 2006 and November 2008, during a period of strong upwards trajectory for natural resources. People who invested during that time again are likely to have subsequently had a comparatively poor experience.
So what are some of the themes currently attracting attention, being promoted heavily, and therefore to be wary about?
Among the most prominent at present are equity income, low volatility equity funds, and objective-based investing. Others include emerging market debt and absolute return-style fixed income funds.
As we’ve seen, however, even if there are apparently sound rationales for investment, clustered fund launches around a particular theme during a period of strong performance can subsequently lead to substandard investor experiences.
Julian Robertson is a senior research analyst with Morningstar.
