How to know what funds to sell in your year-end review

Conducting your end- of-year portfolio review is important but investors should be wary of selling their laggards for the wrong reasons.

People often use the last days of December to look at their portfolio and make changes, but a fund that has done poorly this year might not be a bad investment and could lead the pack in 2021 if markets change direction.

Knowing which funds to sell – and when – is one of the hardest things to get right. Telegraph Money asked fund managers for the red flags to look for when decideding whether to stick or ditch.

BRITAIN Richard Hallett, who runs the £267m Marlborough Multi- Cap Growth portfolio, said investors in Britain should be wary of companies with a high amount of debt. While loans can be useful, when it gets out of hand it can prove fatal.

“An example of this was the demise of Carillion, the construction company, which collapsed in 2018 under the weight of a £1.5bn debt mountain it could no longer afford to repay,” he said.

Many companies have borrowed heavily to survive the pandemic, but while expectations are for a rapid bounce back in growth, “it is possible that over the medium term this may not be as strong as many hope”, he warned.

Investors should first check the fund’s monthly factsheet or annual report for a list of its largest holdings. They can look at how much debt each company has by searching the financial reports, often found on the company’s website. The balance sheet section will show both debt and cash levels.

“If you add together short-term debt and long-term debt, you’ll get the total figure. Subtract cash and equivalents from this and you’ll have the net debt,” Mr Hallett said.

EMERGING MARKETS Veteran investor Mark Mobius, who runs the £ 115m Mobius investment trust, said investors should focus on diversifying when it comes to the emerging markets.

Unusually for an active fund manager, he said investors should buy exchange-traded funds – passive portfolios that track the entire market.

“As there are more than 70 emerging and frontier markets, I would suggest getting core exposure to leading emerging market companies in growing countries such as China and India through an ETF,” he said.

Investors should then add an active fund to complement this, picking a portfolio that does not invest in the same stocks that dominate the index tracker. Investors can find this on the fund’s factsheet. The “active share” figure is a percentage and tells how much of the portfolio is in common with the index. The higher the number, the less in common the fund has with the benchmark index.

If this is unavailable, comparing performance against the index, as well as looking at sector weightings and the top 10 holdings, will indicate whether the fund is too similar to the ETF.

GLOBAL When investing globally, investors should look at themes, rather than individual holdings, as the remit for fund managers is broader.

James Thomson, manager of the £3.1bn Rathbone Global Opportunities fund, said funds should be sufficiently invested in America and the large technology names. Since 2005, US firms have grown profits more than four times faster than the rest of the developed world, largely due to the FAAMGs – Facebook, Amazon, Apple, Microsoft, and Google owner Alphabet. It has been one of the best places to invest again this year and funds that have a relatively low weighting to the region will have struggled.

Although it is tempting to sell your winners and buy “value stocks” – cheap companies that could rebound – Mr Thomson said this would be a mistake. “America should form the largest part of your portfolio because that’s where the growth is,” he said.

BONDS Richard Hodges, manager of the £2.1bn Nomura Global Dynamic Bond fund, said the key for bond investors in the coming years would be their view on interest rates. Principally, bonds generate returns when interest rates are cut and inflation is falling.

This has been the case for 30 years, and while that may not change, it is sensible for investors to reduce the “duration”, which is the fund’s sensitivity to interest rates. When rates rise, funds with higher duration lose out, and when rates fall the reverse is true. The larger the duration in a fund, the greater impact an interest rate move has. For example, if a fund has a duration of 10 years and interest rates rise 1pc, it will lose 10pc.

“You want to avoid long- duration funds, such as typical British government bond funds, as they do not pay much income and investors have already made the maximum they can from capital gains,” he said. “You need to invest in a fund that can make returns when the perfect scenario we have had for a decade ends.”