Where to turn when the stars have fallen

Smaller funds could beat the big names in your portfolio

Size is the big issue of 2020. Not so long ago, it felt hugely comforting to be an investor in an extra large stock market fund, run by a star manager.

The fund’s scale seemed to provide the ideal mix: security, plus the power to outperform.

But then came Neil Woodford, bringing in his wake worries about other popular funds.

Concerns have been mounting that big name funds may be just too big and also illiquid in the event of a downturn.

Criticism is being levelled at their typical share selection strategy. The ‘growth’ investing style has yielded generous rewards over the past decade.

But it is under threat from the new enthusiasm for ‘value’ investing which involves finding cheap, hidden-treasure shares.

While Woodford’s problems were particular to Woodford, the scandal has sparked anxiety about other star managers and their funds.

The first fund under scrutiny is the £19.7bn Fundsmith equity, managed by Terry Smith, a figure famed for his bumper salary and combative opinions.

This week Smith mounted a defence of his growth-investing principles, following a period when his fund has not been top of its league. The second fund in the spotlight is the £6.7bn Lindsell Train UK equity managed by Nick Train, another maverick and advocate of growth investing.

His credo is that outstanding businesses ‘will create wealth’ so long as you hold onto them. He contends that investors should not regard periods of underperformance as unforgivable lapses. These pronouncements may remind you of the utterances of Warren Buffett, the legendary US investor.

Smith and Train were beneficiaries of Woodford’s fall. But they have also – perhaps unfairly – suffered from the fallout, as has Mark Barnett, manager of invesco Perpetual’s £5.6bn High income and £ 2.6bn income funds. Both of these were formerly managed by Woodford ( pictured).

This atmosphere of fear led to the downgrading of Lindsell Train UK equity by Morningstar, the fund rating group. At the same time, the slowdown at Fundsmith raised suspicions that Smith was being affected by the relaxed vibe of Mauritius, where his operation is headquartered. This week interactive investor, the investment platform, confirmed that Lindsell Train UK equity would stay on its Super 60 best buy list, following a review prompted by Morningstar’s move. Dzmitry Lipski, interactive investor’s head of funds research, ruled that the fund did not face liquidity issues. Fundsmith UK equity is also a Super 60 recommendation, an accolade that Smith is rightly eager to retain. His pledges to his investors included a vow that, if need be, ‘57pc of the fund could be liquidated in seven days’. The controversy over best-buy lists (despite its closure, the Woodford fund remained for a while a Hargreaves Lansdown recommendation) suggests that interactive investor will be taking extra care over its rankings. The Barnett funds do not appear on any best buy lists. But while you may be willing to give Barnett more time to remedy his funds’ issues, and be prepared to place trust in Smith and Train, it would still be short sighted to ignore the shift in thinking on fund size and strategy. The principal advantage of a big fund is that it can out muscle the rest, but only if it retains the capacity to achieve its aims.

Jason Hollands of investment platform Bestinvest says: ‘A fund that invests in government or corporate bonds gains from its size because it has a better chance of securing a good allocation of stock in a new issue. But when a fund that invests in shares gets bigger, it may start to lose the dynamic that propelled its growth.’

As an alternative to the big names, investors could seek out flexible, middle-sized funds that also hold blockbuster shares. Options include the £3.7bn TB evenlode Global income and the $738m GuardCap Global equity.

Those prepared to be more adventurous could opt for value funds such as Fidelity Special Situations which Hollands cites as his favourite.

Smaller companies are back in favour. Already money is flowing into such funds as Blackrock Smaller Companies and Henderson Smaller Companies (which are both investment trusts), and TB Amati UK Smaller Companies.

You could say investors taking this route are succumbing to trends, but a diversified portfolio, with a mix of investment styles and sizes of funds will always be in vogue.