Having been involved in the business of analysing and selecting funds for more years than I care to remember, I would be a very rich man if I received £1 for every time I was contacted by a representative of an asset management firm telling me about how good the performance of one of their strategies is… or should that be was? Obviously, performance is past tense, it’s what has already happened and as the commonly used disclaimer states ‘past performance is no guarantee of future returns’. 
So, how important is past performance and how can we tell if a fund manager is doing a good job?
I’ll come on to the former point shortly, but to answer latter part of the question, the FCA, as part of their Asset Management Market Study, has attempted to address this by highlighting the importance of funds having clear objectives that gave investors a better understanding of what a fund is seeking to achieve.
This should then allow investors to measure whether the manager is doing a good job. The FCA’s deadline for firms to meet their requirements on objectives (as set out in PS 19/4) was a little over a year ago and we would argue that the quality of responses from the asset management industry has been a mixed.
To illustrate, below are two examples of objectives found on the July 2021 factsheets of funds that currently reside in the IA UK All Companies sector:
Fund 1: To grow capital over a five-year period.
Fund 2: To outperform (after deduction of costs) the FTSE All-Share Index by at least 2% per annum over rolling five-year periods.
Both have clearly defined objectives, that I would say are written in simple terms, but how can I tell if the respective fund managers are doing a good enough job for their investors?
A core element of the research process at Square Mile is to ask managers to state what it is they are looking to achieve with their strategies and a question we often ask is what can investors expect by investing in your fund? We need to understand how the fund is managed and what impact any biases within the manager’s approach could have on future returns.
This does sound rather simplistic but rather than look at a fund versus its peer group (which is a flawed comparison in our view), why not look at the fund versus what it is the manager is actually striving to achieve? Simple, isn’t it?!
Therefore, clearly the second objective provides investors with a far clearer idea of what the manager is seeking to deliver and, from an analytical perspective, a far more meaningful method of performance comparison.
Linking this back to the question of how important is past performance? We would look at how the fund behaved rather than how it performed during certain periods.
That might sound like semantics, but what if the manager has a very conservative investment approach? Is it appropriate to look at the fund’s returns against a market environment that has delivered 20 per cent returns in each of the past five calendar years?
If the fund has only managed 15 per cent per annum over that period, the cumulative return would suggest that the manager is doing a poor job. However, within the context of what he/she is looking to achieve given the market conditions, this result may actually be admirable.
We would also advocate looking at performance in respect to how much risk the manager taking to deliver the fund’s returns and we are increasingly mindful of cost. In the same way as looking at a Sharpe ratio, for example, to analyse risk adjusted returns, we also look at the total cost of investment relative to outperformance. This allows us to determine if the fund, despite a strong track record, is, in our view, offering adequate value for money.
Within the performance section of the Fund Dashboard, Square Mile and FE fundinfo provide the fund’s three-year annualised absolute return as well as calculating its performance success. We believe the second ratio is very useful as it provides a quick and easy measure of how successful the fund has been over the period of its stated performance objective – the higher the number the greater the level of consistency the fund manager has of meeting the fund’s performance objective.