When assessing multi-asset fund performance, it’s far too easy just to make a judgment call on the manager based solely on how a fund has done versus its benchmark. Unfortunately many investors still use this approach in selecting funds. Yet let’s be frank, this just does not cut the mustard. There are simple reasons why this approach is fundamentally flawed. It is tantamount to comparing apples with oranges. For all intents and purposes, particularly in the short-term, these types of comparisons are meaningless.
The IA Mixed Investment 20-60% Shares sector is an excellent case in point. At the time of writing the top performing funds in this sector include yield-chasing distribution funds, ethical funds and a variety of cautiously-managed funds. An eclectic, mixed bag of funds to say the least, with the sector by definition holding from 20% to 60% in equities. How on earth can a fund with 20% in equities be compared to one with 60%?
With such a variety of different fund offerings, all doing different jobs, investments should never be compared on performance alone. Advisers need to ensure a given portfolio of investments is suitable for a client. Using peer-group performance in isolation may end up with a client’s money being invested in an unsuitable fund.
Mixed up incentives
The fund manager of a retail multi-asset fund invariably liaises with an intermediary rather than the end investor. This typically means there can be a disconnect between the fund manager and the requirements of the end investor. Financial advisers in this sense ensure the manager’s approach is right for their client. However, manager incentives may not be closely aligned with advisers’ needs, suitability requirements or investor expectations.
For example, peer-group benchmarked fund managers have traditionally been incentivised to outperform their benchmark. However, if the evaluation period is over a short-term time horizon or the level of outperformance is closely correlated with manager remuneration, the fund manager might be incentivised to take more risk than the client actually wants. Taking more risk than necessary may render the fund unsuitable for end investors, which stores up potential future mis-selling risk for the adviser.
For these peer-group benchmarked funds, poorly-aligned incentives are a real issue, as the objective is usually to outperform a pre-determined peer group such as the IA Mixed Investment sector rather than meet the right client outcome. The right outcome for a client could be to keep costs reasonable, to keep their investments within their risk tolerance and to have an outcome that is consistent with their original investment goals.
