Keiron Root turns the spotlight on those investment funds that have outperformed through several market cycles

As we will all be very well aware, past performance is no guarantee of future returns. However, the performance record of a particular fund during past cycles – especially if it has been run by the same manager or team for a significant period – is as good an indication as we are likely to get of how it is likely to behave in similar situations in the future.

More generally, it is instructive to look at which types of funds have delivered the best
performance numbers over longer periods. With share-based investments, in particular,
the argument runs that they are for the medium to long term. You shouldn’t judge
an equity fund on the basis of short-term volatility, but in terms of its total return over
a reasonable length of time.

A cyclical business
After all, investment is a cyclical business. Ashok Shah, chief investment officer at London & Capital, explains, ‘The starting point is to accept that you will always have cycles in the return that you will get from markets and from asset classes. Then, on top of that, you will have sub-cycles in individual sectors. Secondly, there are a lot of long cycles, which means that the level of risk attaching to a particular asset isn’t constant over time.’

He adds, ‘For example, a year and a half ago, government bonds were regarded as a very lowrisk asset.Now they are entering a higher-risk category. You need to understand how cycles work and where you are in those cycles.The third element is understanding how each asset relates to each other asset – in other words, the “correlation cycle”.  Some assets have a very high correlation with each other and others have very
little, and you need to understand this in order to diversify your portfolio.’

So it is important to at least monitor how different funds, reflecting different pools of
assets, perform relative to each other over time. At the same time, not all funds with
similar portfolios and objectives will perform in a similar way, and gauging the value
added by a particular management strategy is also important.

Specialist success
That is what this survey sets out to do, at least in very broad terms. When we last conducted this exercise, just over a year a ago, one of the most surprising aspects was that it was the specialist funds, particularly those investing in China and other Asian single markets, that came out on top over ten and 20 years.

In terms of the best individual performances, that is still the case, although there is a much broader range of funds near the top of the open-ended tables, with commodity-based portfolios and US- and Latin America focused funds competing with the China funds for the top spots.

But when you look at overall sectors, the magnitude of the most recent crash certainly
seems to have had an effect. For although Blackrock Gold & General, for example, is clearly the best performer over ten and 20 years (it does not have a 30-year track
record), the charts for the regular savings returns for selected open-ended fund sectors
over the same periods indicate that, on average, bond funds have done better than equity funds over both periods, with gilt funds performing best of all over 20 years.

This would appear to contradict the accepted logic that regular savings benefit from being in the most volatile sectors over time.Certainly, the dramatic falls in equity values in the last quarter of 2008 will have had an effect, coming at the end of the period measured, but such numbers also reflect the fact that, for over a decade, returns from shares have not enjoyed the sort of premium over returns from other asset classes,
particularly bonds, that was once taken for granted.

On current figures, the IMA UK All Companies sector average, for example, doesn’t
even cover the amounts invested over ten years.

Choosing the right manager
The other crucial point that the figures underline is that, if you are going to stick with one fund over a long period of time, the manager you choose is of crucial importance.

For while there is a degree of variation in the performance of bond funds, it is nothing like as great as that which characterises the more equity-orientated sectors.

This will create a dilemma for investors.The best-performing funds, at least in the openended fund survey, are the specialists, where you are relying to a greater or lesser extent on the skill of the manager to pick the right stocks to maximise returns when the sector is doing well and minimise losses when it is not.

The problem is that most investors will want to spread their risk rather than back a single
fund management team. This is where the comparison with the closed-ended funds is
revealing. Although there are a significant number of open-ended funds that invest in
portfolios of global equities, there is no direct open-ended equivalent of generalist investment trusts, with their broad international spread of both markets and assets.

Focussing on risk
Ashok Shah also argues that ‘If you are risk driven, rather than return driven, then your
ability to consume certain assets will go up and down throughout the cycle. If you set a target level of risk and the risk attaching to a particular asset has increased, then you are
going to be able to invest less of your portfolio in that asset. You are going to be forced to put more money into cash, for example, even when rates are as low as they are at the moment.’

Indeed, the argument in favour of long-term diversification is borne out, to some extent, by the investment trust performance figures.

Admittedly, once you get to the 30-year table, a greater proportion of the universe is made up of traditional generalist trusts than is the case over, say, ten years, but the fact that so many of them appear in the table of top performers indicates the worth of maintaining a balanced portfolio over time.

The other key point, which will not be lost on the devotees of the closed-ended investment company, is that, over the longest period, these broadly based portfolios are
generally outperforming the open-ended funds. Of course, performance comparisons
between open-ended and closed-ended funds are fraught with difficulty, but the general
impression from the current numbers is that closed-ended funds tend to do better than
similar open-ended funds over time, and the longer the period under consideration, the
greater the gap becomes.

Changing with the times
Another reason for going with a more broadly based fund is that the degree of correlation between different assets also changes over time. Ashok Shah points out that ‘Because correlations are unstable, you have to monitor what is in your portfolio. For example, look at the high-risk segment of the fixed-interest market and then look at equities.

‘That relationship is not strong most of the time. But when you are in a period of stress –
as we are at the moment – then the higher-risk element of fixed-income actually behaves like equities, whereas in a boom it behaves much more like the lower-risk end of fixed-interest, with very little correlation to equities.’

This change in the relationship between asset classes might also help to explain why
regular savings into UK Gilt funds appear to have done so much better than similar savings into UK equity funds over the past two decades. If the same 20-year calculation was made to the end of June 2008, for example, the Gilt index would show a return of
£40,597.98 but it would be comprehensively beaten by the UK All Companies index at
£54,749.87, an indication of how even longterm regular savings schemes can be affected by a sharp market downturn.

That dramatic difference in the figures for UK All Companies funds in the space of six
months underlines how performance figures are constantly changing.This is why investors need to regularly monitor not only their current holdings but also the wider market to see whether they are due a change of strategy.

What these figures do illustrate, however, is that not all investment funds are the same, and by picking the right fund you will achieve superior returns over time.