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More fruitful comparisons

It is the time of year when investment managers start to finalise their forecasts for the next year and there is an almost universal view that 2007 will see a perfect soft landing for the economy, with a minimum of disruption.

Everyone in this industry knows the consequences of comparing apples and pears. It is hard enough telling funds apart when you know all about them, let alone if you mistakenly categorise the different types of fruit available. The sheer surge in the number of funds (31 per cent of funds registered for sale in the UK are less than five years old, according to Lipper) and increasing complexity (non-Ucits retail schemes, use of derivatives, geographical remit expansion) mean that fund selection is a full-time job and this has led to the growth of funds of funds.

A consequence of this is the call from some that funds of funds should be given their own sector, or sectors, within the Investment Management Association’s classification scheme to enable like to be compared with like. Here at T Bailey, we think this is the wrong way to go.

Fencing off funds of funds into their own classification will tell which funds of funds are doing well by comparison with others but will not let funds of funds as a genre prove their worth. Only by including funds of funds with other non-funds of funds will one be able to see the value added by funds of funds.

An investor seeking, say, growth from equities worldwide should look in the IMA global growth sector and be free to see the performance of all funds in that sector against one another, regardless of how those funds seek to meet his or her objective. If funds of funds are not prepared to stand comparison with all funds seeking the same broad objective, then we really should give up and go home.

Funds of funds is a solution to achieve an investment objective that is common among other funds. It just happens to be one that has a demonstrated track record of success. It is the Granny Smith to the Golden Delicious of single-manager funds – not a different fruit altogether.

A more pertinent question is over how long a performance period should funds of funds be judged against other funds? A number of funds of funds have had a challenging summer after the May/June correction but are recovering. Question marks have been raised unfairly about short-term performance but the real value of funds of funds is over the longer term as the numbers below show.

Within the last five calendar years, unfettered funds of funds in the IMA global growth sector have been in the first quartile in 34 per cent of all three-month periods. A fund has a 25 per cent chance of being in the first quartile, on the assumption that there is no manager skill and everything is a random walk, so a score above 25 per cent would indicate added value. Over six months, the figure is 36 per cent, one year 40 per cent, two years 45 per cent, three years 50 per cent and so on. So after three years, funds of funds typically appear in the first quartile twice as often as they should, that is, 50 per cent of the time versus 25 per cent.

The conclusion is that funds of funds work better relative to other funds the longer you give them. The reason is they have more opportunity to use their structural advantages. If as an industry we are not prepared to be judged against other funds, we should go and pick fruit for a living.

Jason Britton is fund of funds manager at T Bailey


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