How do you know if your fund manager has lost their mojo?

We’ve all seen it. From Kevin Bacon through to Will Smith, sometimes even A-listers come down to earth with a bang. Rather than starring in the latest Hollywood blockbuster, they become a parody of themselves, and may even turn up in a cringey advertising campaign for something as banal as a mobile phone network.

Sometimes bright stars simply burn out, trip up, or lose the plot, and the world moves on. But if the fund manager running your money goes off the boil, it could have serious implications for how your investments grow, and whether you meet your savings goals. So how do you know if your fund manager has lost their mojo, and what do you do about it?

This is a particularly pertinent question at the moment, because two of the most popular funds of recent years, Fundsmith Equity and Scottish Mortgage, have had a pretty terrible 2022 so far. Fundsmith Equity has fallen in value by 16%, Scottish Mortgage by a breath-taking 44% – in the space of just six months.

Investors might normally be spitting feathers at such performance. But as these funds have delivered exceptional returns for investors over the long term, their managers have considerable credit in the bank. All long periods of underperformance start with a short period of underperformance, though – so how do you know when it’s time to ditch your active manager?

The first thing to do is take a look at performance. Fund price movements up and down are clearly what ultimately matter most to investors, but if you’re assessing an active manager, you need to set their performance in context by comparing it to an appropriate yardstick. Both Fundsmith Equity and Scottish Mortgage are global funds, so it makes sense to compare them to the performance of the global stock market.

Happily, you don’t need to tot up the performance of thousands of shares across the globe yourself. An index does this for you. The most famous and widely used global index is the MSCI World – so for global funds like Fundsmith Equity and Scottish Mortgage, this is the most appropriate comparison. Similarly, if you were assessing a UK fund, you would probably use the FTSE All Share as a comparator. Most funds will provide details of the relevant index for comparison on their factsheet. Most will also provide performance of their fund versus that index too, but occasionally you might need to do a bit of digging.

The MSCI World index has also performed poorly this year, falling by 10%. Fundsmith Equity and Scottish Mortgage have done worse still, so by this measure they’re still in the doghouse. However, six months is a really short time over which to judge a fund manager’s performance. If you’re not prepared to accept six months of underperformance every now and then, you should probably opt for index trackers rather than active funds. These funds simply mimic the performance of the stock market, minus charges – which are normally pretty small because this investment approach is relatively simple.

Looking at Fundsmith Equity and Scottish Mortgage over a longer time period, things start to get better. Over five years Fundsmith Equity has returned 65%, Scottish Mortgage has returned 92%, and the MSCI World Index has returned 57%. So while more recent performance of these funds has been weak, if you zoom out a little it isn’t so bad .

Sometimes you might find that even over longer time periods, your fund manager has underperformed. If this is the situation you find yourself in, it might be a good idea to ask yourself why you invested in the first place. Clearly you had conviction in the fund manager once, so consider if anything has fundamentally changed that should lessen that.

In the case of both Fundsmith Equity and Scottish Mortgage, it isn’t that the managers have changed their investment approach. It’s that the market has turned against their style of investing and the particular companies they’ve invested in. Of course, the longer underperformance goes on, the more that will legitimately undermine your confidence. So how long a period of underperformance should you put up with?

This is a tricky question, because markets can turn against a particular style of investing for long periods. As a general rule of thumb, a year of underperformance should put a fund on your watchlist. Three years should prompt a serious review when you decide to renew your vows or part ways with your manager. After five years of underperformance, you need some very good reasons to keep the fund in your portfolio, rather than moving on to pastures new.

Also bear in mind that a truly diversified portfolio of active funds should have a mix of different fund managers styles. At any one time some will be desperately unfashionable, others flavour of the month. So in a balanced portfolio, it’s normal to have some funds racing away, and others struggling to keep up.

Overall, as a fund investor, you have a choice when it comes to dealing with fund underperformance. Either you cut and run at the first sign of trouble, or you sit and wait it out. If you jump ship quickly, you might get out of some funds before a long downturn in performance, but equally you’ll miss some that bounce back. Meanwhile, you’ll also rack up trading costs and spend a lot of time and effort moving your portfolio around. You’ll also have to move your money into another fund – and who’s to say the new one isn’t about to endure a period of underperformance too.

If you choose the patient route, you avoid these issues. Sometimes you’ll end up holding a fund for longer than you would with perfect hindsight, and you’ll suffer some underperformance as a result. But in a well-diversified portfolio, other funds should take up the slack. On balance it’s probably better to show a little faith in your chosen fund manager, even if it’s occasionally not rewarded.

Fund performance data from FE, total return in GBP to 29th June 2022