How to Spot a Dog Fund

Investing has never been easier, even for beginners. We have detailed information and analysis accessible at the touch of a button. Investment platforms are widely available and provide access to funds and shares across every asset class, world region, and business sector.

But all this choice can make investing seem impossibly complicated. We all know that fund values go up and down. A key principle of successful investing is to hold assets for the long-term. This means keeping your resolve and avoiding the temptation to sell during a downturn. 

But some funds appear to consistently underperform. 

In this guide, we look at ‘Dog Funds.’ What are they, how can you spot them, and should you hold them in your portfolio?

What is a Dog Fund?

A dog fund displays the following characteristics:

• It has underperformed against the benchmark for three consecutive 12 month periods, and;
• It has underperformed by 5% or more for the duration of the three years.

Lists of dog funds are published regularly. Additionally, anyone can access fund performance information by downloading a fund factsheet or referring to a website such as Morningstar or Trustnet. 

So in simple terms, it is very easy to spot a dog fund. 

What Does the Data Tell Us?

If an investment meets the criteria of a dog fund, we know that:

• The underperformance has been consistent, and not just over an isolated period.
• The underperformance has occurred over discrete periods, rather than being skewed by one major downturn.
• The underperformance has been reasonably significant. 

But this does not tell the full story. What Else Should be Considered?

Regardless of whether a fund is a ‘dog,’ there are numerous other pieces of information that need to be taken into account.

Charges

Performance figures are quoted after fund charges are taken into account, so if you are comparing two funds, the impact of charges on past returns has already been factored in. But as future returns are unpredictable, comparing charges is a good start when weighing up investment choices. 

We cannot predict how a fund will perform. But we can say with certainty that every 0.1% in charges will reduce your investment return. 

So if one fund charges 0.5% per year and another charges 1.5%, can you be sure that the higher charging fund will consistently achieve an extra 1% per year in investment performance?

It’s important to be clear on charges before you invest. This is not always as straightforward as it sounds. The headline Annual Management Charge (AMC) only tells part of the story. In addition, there will be transaction and brokerage charges taken behind the scenes. In some cases, a fund with an AMC of 0.75% could cost as much as 2% per year when all charges are taken into account. 

If this information is not clear from the fund literature, you should contact your adviser or the fund manager for further details. 

Volatility

Volatility measures the extent of the ups and downs in fund performance. There are numerous mathematical formulas and risk profiling tools that can help you work this out, but the simplest way to get a sense of an investment’s volatility is to look at the performance graph.

If the performance line appears more steady than the benchmark, this could indicate that the underperformance is due to taking less risk. 

On the other hand, if the fund performance swings more wildly than the benchmark, this suggests that not only has it underperformed, but it is more volatile.

The gold standard of investing is high performance and low volatility. Of course, there is no single investment that meets this description, and it is usually a matter of seeking an acceptable balance of risk and reward. A fund which consistently displays high volatility and underperformance is best avoided. 

Asset Allocation

It’s also worth considering what the fund invests in. 

As an example, the Mixed Investment 40% – 85% sector is a broad indicator of a ‘balanced’ investment portfolio, and includes around 189 different funds.

But within this (or any other) sector, the funds can vary hugely. For example:

• Funds have different levels of equity content. A fund holding 40% in shares will behave differently from a fund holding 85% in shares, and yet both are compared against the same benchmark. 
• They can be actively managed or track the market.
• They might have a UK bias or be globally diversified.
• They could target growth stocks (for example, technology companies, which thrived throughout 2020) or value (steady, dividend producing businesses) or a mixture of both.
• Funds may have a particular focus, for example ethical investing or generating income. 
• They could have different investment mandates. Does the manager have full discretion over what they hold, or is the fund managed according to fixed parameters? The asset allocation may not be the same in 12 months.
• You should also consider how the fund interacts with your other investments. Does it introduce further diversification or are you buying more of the same?

Should You Invest in a Dog Fund?

If a fund is a ‘dog,’ there could be several reasons for this that do not detract from the fund’s quality, e.g.

• It may take a lower level of risk than the sector average.
• It could have been impacted by specific market conditions.
• Perhaps it has a particular investment objective that means it is inappropriate to simply measure performance in line with the benchmark.

When selecting a fund, it’s vital to look ‘under the bonnet’ and consider more than performance. Our top tips for successful investing are:

1. Hold a wide range of diverse investments.
2. Keep charges under control.
3. Take an appropriate level of risk for your circumstances and goals. 
4. Invest for the long-term.
5. Understand what you are investing in and don’t be led by trends.