Why fund managers who follow the crowd are letting their investors down

Funds are copying each other by taking on more risk with your money. Jonathan Jones investigates

Herd mentality among fund managers has disappointed investors who had hoped their actively managed British funds would protect them from the market crash in March.

From the FTSE All Share’s high point on Jan 17 to its trough on March 23, just one in three funds beat the index of British shares. In the market rebound since then, two thirds of funds outperformed the index. Overall, fewer than half of actively managed British funds have returned more than the index in 2020 so far.

After a decade of rising returns with few market falls, fund managers have taken on more risk to beat their benchmarks. As a result, most were not equipped for a market fall and remain highly invested in risky stocks that could suffer if it drops again.

One of the reasons investors buy funds is to make sure their holdings are “diversified”, which means that they own a variety of stocks and therefore spread the risk if a company or sector were to get into trouble. Some investors own multiple British funds in the belief that the more they own the more diversified their portfolio will be, but this may not be the case.

Brian Dennehy of FundExpert, an investment shop, said: “When we get very short periods when a high proportion of funds are outperforming the index, we know this results from herding rather than skill.”

This means fund managers are all buying the same stocks that have previously done well. He said professional investors had been trying to replicate “growth” funds, which have performed best in recent years. Managers who invest this way buy shares in firms that can continue to grow their profits, sometimes with little regard for valuation.

“Most of these funds were not previously following the ‘growth’ style that outperformed in 2019, at least not terribly successfully, so they piled in at the first sign of weakness, in March,” Mr Dennehy said.

The situation is worse for funds that focus on providing an income. Just 21pc of British income funds beat the market in the downturn and 41pc were able to take advantage of the rebound.

Income funds have been hit hard as some companies have scrapped dividends to conserve cash and ensure their survival during the crisis. Businesses that paid large dividends, such as banks, oil companies and retailers, have largely cut or stopped their payouts, which has caused their share prices to fall significantly.

Active managers’ inability to beat the market is not limited to income funds or to the recent market turbulence. Mr Dennehy’s own research suggested that as few as one in 10 funds available to investors had beaten a comparable passive fund over the past 10 years.

“Like investors generally, fund managers are not terribly good at trying to exploit trends, either missing them altogether or being very late to the party, as is the case now,” he said.

For many investors, a stock market tracker, also known as a passive fund, is a good way to invest. This gives them broad exposure to British companies without the potential to make major mistakes.

The SPDR FTSE UK All Share ETF is Telegraph Money’s favourite for people who want to invest in Britain. It includes nearly 600 companies in the

‘Fund managers are often very late to the party’

FTSE All Share index and is very good at mimicking its performance. With an annual charge of 0.2pc it is not the cheapest passive fund to cover the market but rivals are much smaller and are less accurate at tracking the index.

For those who prefer to trust a fund manager to beat the market when it is both rising and falling, the Royal London Sustainable Leaders Trust has been the best British stock market fund this year. It has lost just 1.4pc while the

FTSE All Share has dropped by 15pc. The fund is one of the 18pc of British funds to beat the index both in the market fall and in the rebound.

Finding an income fund to beat the market in both periods was more difficult. Just 9pc of funds managed the feat. The top performer was Miton UK Multi Cap Income, which is down by 5.8pc in 2020. The fund invests across the market spectrum and owns a large number of smaller companies.

Fewer than half of actively managed British funds have returned more than the index in 2020 so far