£67bn Trapped in Underperforming UK Funds – A Wake-Up Call for Investors

Why Investors Must Rethink Their Fund Selection Strategy

The latest "Spot the Dog" report by Bestinvest has unveiled a stark reality: UK investors have a staggering £67.4bn trapped in underperforming funds, a 26% increase from just six months ago. With 137 funds labelled as "dogs" due to persistent underperformance, this trend underscores the critical need for active fund selection and regular portfolio reviews. Alarmingly, 15 of these funds individually manage over £1bn, together accounting for 60% of the total wealth held in these lacklustre investments.

Key Findings: Which Funds Are Struggling?

Among the worst offenders is the Lindsell Train UK Equity Fund, managed by renowned investor Nick Train. Despite delivering 430% growth since its inception in 2006, it has underperformed its benchmark by 18% over the past three years. Similarly, St James’s Place (SJP) Global Quality Fund, managing £9.4bn, underperformed its benchmark by 26%. SJP’s Sustainable and Responsible Equity Fund also lagged by 24%, highlighting a broader struggle among sustainable investment strategies.

Interestingly, some of the worst-performing funds have a sustainability and ESG (Environmental, Social, and Governance) focus. These comprise a quarter of all dog funds, reflecting the challenges ESG investments have faced amid a shifting macroeconomic landscape. The MSCI Global Alternative Energy Index, which tracks the performance of alternative energy stocks, declined by 48.8% over the past three years, in stark contrast to the MSCI World Energy Index's 71.3% gain in the same period. This divergence highlights how rising energy prices and geopolitical instability have favoured traditional energy stocks over green investments.

Macro Trends and Market Forces at Play

Several factors have contributed to this widespread underperformance:

• Rising Inflation and Interest Rates: The post-pandemic economic environment has been marked by inflationary pressures and aggressive rate hikes by central banks. Growth-oriented and ESG funds, which often invest in capital-intensive industries, have been particularly affected by higher borrowing costs.

• Energy Market Dynamics: The surge in global energy prices following Russia’s invasion of Ukraine in 2022 has created a difficult environment for alternative energy and sustainability-focused funds, while fossil fuel investments have flourished.

• Sector-Specific Challenges: Many of the underperforming funds are highly concentrated in consumer discretionary and alternative energy stocks, both of which have struggled amid changing economic conditions.

MY ANALYSIS: The Importance of Active Portfolio Management

This growing pool of underperforming funds raises several important considerations for investors. While many of these funds have historically outperformed, past success does not guarantee future results. The data suggests that investors cannot afford to be complacent—a buy-and-hold approach in actively managed funds requires periodic re-evaluation.

Additionally, the underperformance of many large, well-known funds dispels the notion that size alone correlates with stability or superior returns. Instead, investors must assess funds on key performance metrics, including:

1. Rolling Returns vs Benchmark Performance – A consistent underperformance against benchmark indices over consecutive periods signals potential structural issues in fund strategy.

2. Fund Management Strategy – Concentration risk, sector biases, and active decision-making play a crucial role in long-term success.

3. Market Environment Suitability – Funds investing in sectors that are out of favour (e.g., ESG and renewable energy) may continue to struggle unless macro conditions shift.

The Path Forward: How Investors Can Protect Their Wealth

To avoid being caught in underperforming funds, investors should adopt a proactive approach:

• Regularly Review Fund Performance: Funds should be evaluated at least semi-annually to determine whether they are still aligned with your investment goals.

• Consider Passive Alternatives: Index funds and ETFs tracking broader markets often outperform actively managed funds in the long run, particularly when fees are considered.

• Diversify Across Asset Classes: A balanced portfolio, incorporating a mix of growth, value, and defensive assets, can mitigate the risks associated with sector-specific downturns.

• Scrutinise Fees and Charges: High management fees can erode returns, especially in underperforming funds. SJP, for example, has acknowledged the impact of its ongoing charges on performance and plans to revise its fee structure.

Final Thoughts: A Lesson in Investor Vigilance

The sharp rise in wealth tied up in underperforming funds should serve as a warning to investors. Whether due to sectoral headwinds, management missteps, or macroeconomic shifts, consistent underperformance must be addressed. Investors should take an active role in assessing fund performance, adjusting their allocations accordingly, and being mindful of market trends that could impact long-term gains.

While some underperforming funds may recover, blind loyalty to a fund based on past performance is not a sound investment strategy. In a constantly evolving financial landscape, agility and informed decision-making are key to securing and growing one’s investments.