Many years ago I visited a client who I had set up with an investment portfolio that had got off to a cracking start. I was looking forward to the meeting and keenly anticipated congratulations on my brilliant fund selection. How naïve I was.
Instead of praising the performance of the funds that had done well, the client wanted to discuss the two laggards of the portfolio. His proposal was to sell the poor performers and reinvest the proceeds into those that had done better.
If you are feeling generous, you might view this as an early momentum strategy. However, the more likely conclusion was that he had fallen into the short-term chasing-returns trap many amateur investors do.
I explained the purpose of his portfolio was to provide diversification and the obvious outcome is that some investments will perform better than others. As investments tend to move in cycles, the poorly-performing fund of last year could be your best performer in the following 12 months. Provided the initial rationale for buying the investment still applies, it is often worth holding on.
That conversation took place over 25 years ago, but I have had many similar since. I had hoped, over time, investors would realise the importance of viewing a portfolio with the long term in mind.
Take the M&G Recovery fund. Manager Tom Dobell was “golden boy” five years ago but is considered by many today to be a failure. His sin has been a period of underperformance at a time when other funds have done relatively well. There is no denying he has made some mistakes; something he readily admits to. He probably held on to some of his winners too long and his oil and mining exposure has hardly been helpful.
By his own admission, companies such as Kenmare Resources, Gulf Keystone, FastJet and White Energy have taken up a great deal of his time and cost the fund. However, they are small holdings and in normal years there would have been a number of strong performers to offset their losses. Four of the fund’s companies were subject to takeovers last year, providing a welcome boost to performance, but there are usually many more.
Aside from a number of stock-specific issues, there is another reason for the fund’s underperformance. In a world of sluggish economic growth many investors have remained cautious, favouring “quality” companies for their perceived certainty of earnings delivery. This is the type of company the manager naturally avoids, meaning the fund has missed out on the gains made. On the other hand, the recovery stocks he tends to favour have been shunned by the market.
Tullow Oil is one such company. The oil and gas manufacturer has suffered a torrid time and has a large amount of debt on its balance sheet, which in the current environment of low oil prices has made investors wary. Dobell takes a different view, however, as the money is being used for expansion. He believes investors have overlooked the company’s potential.
Dobell’s portfolio of undervalued and out-of-favour stocks currently interests no one and his golden boy status has transferred to managers with a heavy focus on the “quality” companies mentioned previously; funds that are the antithesis of Dobell’s.
With my former client’s views still ringing in my ears, I can understand the temptation for investors in M&G Recovery to switch to a more recent success story. However, my argument back then still stands now. No investment can be successful all the time and there will come a time when the economic environment changes to suit Dobell’s approach.
As it is impossible to know when that might be, a well-diversified portfolio could benefit from holding both types of fund. A foot in many different camps is often a much more rewarding strategy over the long term than taking big bets in one direction.
Mark Dampier is head of research at Hargreaves Lansdown