Big-name funds fall behind smaller counterparts as assets swell

February 17, 2014 12:31 pm

Big-name funds fall behind smaller counterparts as assets swell

By Emma Dunkley

Investors seeking safety in large funds risk portfolio underperformance as the biggest products on the market lag behind their smaller peers.

New research by FE Trustnet shows that investors would have been better off buying an average-sized fund instead of a large one over the past five years in the equity income sector.

An equally-weighted portfolio of the largest UK Equity Income funds returned 88 per cent since January 2009, while the average fund has delivered 104 per cent.

The issue has come to the fore as the manager of two of Britain’s biggest retail funds, Neil Woodford, prepares to depart Invesco Perpetual for small boutique Oakley Capital.

In spite of Mr Woodford’s stellar long-term record over the last 25 years, he has recently underperformed in the UK equity income sector with his behemoth £8.5bn Income and £13.3bn High Income funds.

Data from Hargreaves Lansdown shows he returned 79.8 per cent on the High Income fund over five years to the end of 2013, underperforming the FTSE 100 total return’s 83.1 per cent.

By comparison, the much smaller Invesco Perpetual UK Strategic Income fund, which has assets of only £398m, returned 102.5 per cent over this time.

The issue is not just restricted to equity income funds.

“It has increasingly become conventional wisdom that buying a large fund is a safer bet for client cash,” said Gary Potter, co-head of multi-manager at F & C Investments.

“But think of it like this – however good a ship’s captain, the bigger the ship you put him or her in charge of, the harder it is to manoeuvre.”

Mr Potter added that the problem with large funds is “set to become more troublesome for investors over the next couple of years,” as fund management companies look to control how big these funds become.

Part of the issue is that the products are less able to invest a significant proportion of the fund in small to medium-sized companies, whose stock price tends to rise further than large firms.

In contrast, managers of small funds are more nimble, able to invest a greater portion of the fund in smaller companies and arguably have a wider choice of investments at their disposal.

Yet even wealth managers have been buying a concentrated range of large funds exhibiting mediocre performance.

There are concerns that investors will be exposed if large wealth management firms start to sell out of these funds, such as when there is a manager change, or if performance takes a tumble.

Mr Potter said that he stays clear of many large funds and many of those he has invested in, such as Chelverton UK Equity Income and Fidelity UK Smaller Companies, have capacity controls in place to ensure they do not become too large.