Are you a dedicated follower of investment fashion or a trend setter?

13 September 2012

The annual arrival of London Fashion Week is a reminder that over the last couple of decades London has earned a place as a capital of cool to rival Paris, New York and Milan. Yet away from the catwalks, the City of London, the leading centre for asset management in Europe, has also gained a reputation for financial product “innovation” leading to waves of investment fashions that often prove short lived.

Here, Bestinvest’s Managing Director Jason Hollands, highlights a number of these past fads, and suggests that it often pays to go against the herd.

Privatisation funds

“In the mid-90s, well after Margaret Thatcher had stepped down as Premier, a number of funds were launched promising to harness the global opportunities from the release of state-owned assets into the private sector. These funds attracted much attention but within a few years they had morphed into general equity funds.”

The tech bubble

“In the run up to the Millennium, the markets rewarded “fast growth” technology, media and telecommunications - related companies, as excitement about the potential of the internet reached fever pitch. Many of these companies soared to valuations that looked astronomical compared to their actual earnings but some talked of a ‘new paradigm’ where the old rules simply didn’t apply any more. Many retail investors were lured into fundamentally speculative funds by stellar returns they were delivering, throwing all caution to the wind. While this was a very uncomfortable period for those fund managers who placed a strong emphasis on identifying cheap, undervalued companies, fundamentals have a habit of reasserting themselves, and the bubble ultimately burst with investors racking up huge losses.”

Climate change funds

“Only a few years ago, it was impossible to get through a television broadcast or newspaper without viewing a story that referred to the impact of global warming or climate change. As if on cue, from around 2007, asset managers began launching funds to take advantage of climate change as a theme, investing in companies that might benefit from mitigating the impact of the changing climate or adaptation to it. These were not narrow alternative energy funds but ones which invested in stocks that might benefit from the shift towards low-carbon economy. Generally these funds have gone on to disappoint and investor interest demand has waned.”

130/30 or "long-short extension" funds

“Pre-credit crisis funds that were variously described as ’130/30’, ‘enhanced alpha’ or ‘long-short extension’ funds were heralded as the next big thing, with a flurry of groups launching products or announcing their intention to do so. The pitch at the time was that fund managers see lots of companies that don’t make it into their portfolios, so a traditional product only utilises a small part of the views and judgement of the manager. Instead, “enhanced alpha” strategies would supposedly allow investors to benefit more widely from a fund manager’s views, enabling the manager to run a limited short-book (typically 30 to 50% of a portfolio) alongside a long-portfolio. The cash proceeds from the short book would be utilised to increase the long-position, essentially achieving a supercharged long portfolio with a net market exposure of 100%.

“The credit crisis unfurled shortly after these funds were launched, and the last thing investors needed was experimental, super-charged funds in a market where liquidity dried up and counter-party risk was high on the radar. The result was that many of the 130/30 funds quietly wound up or at least ceased being actively marketed. The idea was interesting but in hindsight the timing was wrong.”

The rise of risk-rated Multi-manager funds

“Multi-manager funds have significantly grown their share of the market in recent years, with many advisers using them as their core ‘solution’ for clients. And while there are merits to this approach in terms of diversification and professional management, the costs are higher and there may be some long-term pitfalls as some multi-managers achieve such large scale this is impacting their ability to invest in smaller funds which may hold the potential for better returns.

Moreover, the fact that these funds are in vogue is to a large degree down to their popularity with advisers wanting to get out of the business of picking funds themselves and to de-risk their business models by ensuring all clients of similar risk categories are in comparable funds and with similar asset allocations. That may not suit those investors who want a more customised approach or who might consider building their own portfolios.”

Passive investing

“Some investors have got out of the business of fund research altogether and are adopting an approach of solely investing in passive investments, such as index tackers or Exchange Traded Funds. The latter types of investments have seen explosive growth over the last decade.

While passive investments can play an important part in a portfolio and make sense in strongly rising markets where an investor needs to efficiently capture the general upward trend at low cost, they are not a panacea and won’t suit every eventuality, especially if markets enter a bumpier phase.

In recent years markets have been heavily driven by policy decisions and the actions of central banks and relatively less so by company fundamentals which has favoured passives over actively managed investments. A return to more normal markets could reveal the flaws of an approach exclusively anchored to passive-investing.”

Targeted Absolute return funds

“Only a few years ago there was flurry of new launches of funds which promised to utilise the greater flexibility of the UCITS IV rules and borrow some of the techniques associated with hedge funds to generate absolute returns irrespective of the market environment. Many of these have quite simply failed to deliver and scepticism is widespread towards the often generous performance fee structures some of these funds put in place. High correlation between different asset classes, driven by the distorting impact of QE has now helped these funds and the next few years are going to provide a chance for some of these managers to redeem themselves.”

Hollands concluded: “Investment fashions come and go and investors need to be wary, as sometimes the driving forces behind new product launches are the sales and marketing departments rather than the investment teams. Firms see new product launches as a quicker way to gather assets than the slower process of developing competitive track records on existing funds. Once one firm comes up with a novel idea for a new fund, invariably there is a rush of 'me-too' products from competitors because the sales teams bleat that they are missing out on new business opportunities.

“New fund launches should not be ignored per se but don’t get wrapped up in the hype and always select an investment based on whether it fits with your overall strategy and existing holdings.

More generally, there is a natural tendency to follow the herd and invest in whatever is flavour of the month, being tipped, marketed or simply performing well. But in fact the art of successful investing is to buy an asset when it is cheap and sell it when it is expensive, so it often pays to be contrarian and invest in areas that are currently unfashionable.”

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