CONNECTION: RETURNS AND SALES

Transcription

1 CONNECTION: RETURNS AND SALES THE RELATIONSHIP BETWEEN FUND PERFORMANCE AND NET SALES IN THE UK NOVEMBER 2012 INTRODUCTION My bags they get a very close inspection I wonder why it is that they suspect em They re dying to add me to their collection And I don t know if they ll let me go. (Connection, 1967) Clearly it is not a surprise to discover that funds with first quartile performance attract the greatest inflows. 1 But this report goes beyond the headline to investigate how the connection between fund sales and performance has changed over the past ten years, with variations by sector, different rolling periods, and relative sales for lower quartile returns. This research focuses on some of the largest IMA Sectors, covering the majority of mutual fund assets in the industry, which also enables analysis of each underlying sector that has a robust and comparable universe of funds. Specifically, the report determines the proportion of net sales attributable to funds with different quartile performance in thirteen key IMA Sectors. Net sales were calculated every quarter for funds with one, three, five and ten year rolling returns. As the aim is to look at the relationship between returns and net sales, funds are ranked by performance quartile every three months. In other words, 25% of those funds in any given period that have the best performance within an IMA Sector are ranked first quartile and the worst 25% are ranked fourth quartile. These peer rankings are compared to the net sales in each quarter at the end of the relevant performance period. Because the performance periods analysed are rolling, this means that the data is analysed in the same way every three months throughout the past ten years (from the third quarter of 2 to the end of the third quarter of 2012), it is not simply a snapshot of one period. However to ensure there is a robust sample size the data for 10year rolling returns starts with the third quarter of 4, i.e. funds that had a performance track record going back to 30 September Some use is also made of the correlation coefficient. This measures the degree to which all performance rankings (not just first quartile, but from first through to fourth quartile) are linked to any given quarter s net sales. Here a correlation of 1.0 suggests that sales are perfectly correlated to each performance quartile. This report looks at how the overall relationship between performance and sales has varied over time, as well as drilling down to look at individual sectors and average figures across the ten year period assessed. Finally some concluding thoughts are provided, reflecting some of the insights that this analysis enables. 1 See also Lipper, Zen and the art of mutual fund maintenance (2010) REUTERS/SOE ZEYA TUN AUTHOR: ED MOISSON HEAD OF UK & CROSSBORDER RESEARCH, LIPPER ed.moisson@thomsonreuters.com Please note that the views expressed in this document are intended as nonconsultative and do not constitute legal advice. Thomson Reuters 2012 All Rights Reserved. This document is for information purposes only and does not constitute investment advice or an offer to sell or the solicitation of an offer to buy any security of any entity in any jurisdiction. No guarantee is made that this information is accurate or complete and no warranties are made with regard to the results to be obtained from its use. In addition, Lipper will not be liable for any loss or damage resulting from information obtained from Lipper or any of its affiliates.

2 ANALYSIS Looking across all thirteen selected IMA Sectors, four charts (figures 1 to 4) show the relative sales of funds each quarter with first, second, third and fourth quartile performance. The charts differ by using different periods of rolling performance: 1 year, 3 years, 5 years and 10 years. As a result one can look not only at how relative performance relates to sales over time, but also by comparing the charts how these patterns vary when investors assess different lengths of past performance. Taking these four charts together, the importance of first quartile performance is undeniable. For 1, 3 and 5 year performance, first quartile funds attracted inflows in every quarter. For 10year returns, the value of first quartile performance is less pronounced, but even here in 25 out of 33 quarterly periods (i.e. more than 75% of the time), first quartile funds in aggregate enjoyed inflows. As the overall sales data presented here specifically excludes some funds (new launches, for example) the evolving sales trends shown cannot easily be used to assess the changing importance of wider market activity on sales. REUTERS/ARKO DATTA It is also worth pointing out that there are inevitably fewer funds with longer track records; this is most pronounced for the number of funds with 10year history. This is partly a reflection of the fact that if a fund s shorter term performance is not good enough and consequently has not attracted significant assets it is much more likely to be closed/merged before reaching ten years. For funds with second quartile performance, inflows are most likely with rolling 1year returns. More than this, second quartile funds based on rolling 1year rolling returns actually register positive sales activity on average across the ten year period assessed but their average is negative for 3, 5 and 10 year rolling returns. This seems logical, for example with fund selectors giving managers the opportunity to improve returns when performance has dropped out of the highest quartile. In a similar way, Lipper s previous research 2 has shown that it has been very rare indeed for a fund to outperform its benchmark over each and every 1year period. However, the sales activity of 1year second quartile funds noted above is an exception, and generally the dominance of first quartile performance in driving sales prevails, with some tough love shown to those that drop out of this top group. 2 See Lipper, Beating the Benchmark (2012) 2

3 FIGURE 1 AVERAGE SALES PER SECTOR 1 YEAR RETURNS ( M) FIGURE 2 AVERAGE SALES PER SECTOR 3 YEARS RETURNS ( M) FIGURE 3 AVERAGE SALES PER SECTOR 5 YEARS RETURNS ( M) FIGURE 4 AVERAGE SALES PER SECTOR 10 YEARS RETURNS ( M) Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q

4 AVERAGES PER SECTOR While the full historical trends are the best way to reflect on market activity in detail, it is helpful to summarise these four charts by calculating averages for each (figure 5) in order to shed more light on the overarching trends. These averages provide a powerful means to show the importance of first quartile performance for delivering inflows, with the sales per sector averaging 173m for funds with first quartile performance over 1year periods, a higher figure of 194m for funds with first quartile performance over 3year periods, 158m for 5year periods, and 45m for 10year periods. By contrast second quartile performance generates average sales per sector of 13m (1year periods), but redemptions of 18m for 3year periods, and then worsening to redemptions of 49m (5year periods) and 52m (10year periods). It is also interesting to compare the net sales for first quartile funds compared to those in the lower three quartiles. Analysing funds with 1year track records reveals that the average sales for first quartile funds outweigh those for all other funds by 85m (i.e. 173m compared to 88m). Despite first quartile funds having greater average sales for 3year returns, their sales only outweigh redemptions from other funds by 6m (i.e. 194m compared to 188m), while the weight of redemptions weigh ever more heavily for 5year returns ( 158m versus 207m, a difference of 49m) and 10year returns ( 45m versus 150m, a difference of 105m). This chart reveals a double whammy for fund managers to watch out for. First there is the importance of first quartile performance (especially over shorter periods) to generate sales. And second the likelihood of redemptions resulting from lower quartile performance increases as the periods lengthen from 1 to 3 to 5 and finally 10year rolling returns. FIGURE 5 SUMMARY OF AVERAGE SALES FOR DIFFERENT PERIODS ( M) st 2nd 3rd 4th 1st 2nd 3rd 4th 1st 2nd 3rd 4th 1st 2nd 3rd 4th Rolling 1year periods Rolling 3year periods Rolling 5year periods Rolling 10year periods 4

5 IMA SECTOR COMPARISONS Taking a different perspective, the initial four charts can be broken down by IMA Sector, with average sales for the different performance periods (1, 3, 5 and 10 years) aggregated into four charts (figures 6 to 9), highlighting how sales activity has varied between sectors. Some of the findings that stand out here include the success in generating inflows for poorer performing funds in the Investment 2060% Shares sector (formerly Cautious Managed sector). This is most obviously the case when looking at 1year returns, but even for 3year and 10year periods lower quartile funds fare relatively well in sales terms compared to the twelve other sectors assessed. In the UK Equity Income sector, looking at the sales of first quartile funds alone one might expect this to be among the bestselling sectors for the different time periods assessed. However the severity of redemptions from third and fourth quartile funds drag down the aggregate inflows to this sector. Such activity likely reflects the dominance of a few funds in this sector, with three funds accounting for 45% of sector assets (Invesco Perpetual s two Neil Woodfordmanaged funds and Artemis Income). REUTERS/DAVID MDZINARISHVILI For equity funds more generally it is worth noting that this asset class has been largely out of favour since 8 and this is reflected in the findings for European, UK and UK Smaller Companies funds (although first quartile performance helps even here, albeit not for 10year returns). Having said this, Emerging Markets and Asia Pacific funds present different results, with first quartile sales generally outpacing all other funds (except for 10year data). The former sector in particular has seen very limited outflows, even when looking at aggregate data for poorer performing funds. Picking out three sectors ( Corporate, UK All Companies and Investment 2060% Shares) that form a core part of the three broad asset classes of bond, equity and mixed assets, serves to show how the overall trends established in the previous section can vary for different sectors and at different times. 5

6 FIGURE 6 AVERAGE SALES BY SECTOR 1 YEAR RETURNS ( M) , Corp Strat. Asia Pac ex Jap Europe ex UK Flexible Inv Emg Mkt 2060% 4085% North America UK All Cos UK UK Small Equity Inc Cap FIGURE 7 AVERAGE SALES BY SECTOR 3 YEARS RETURNS ( M) , Corp Strat. Asia Pac ex Jap Europe ex UK Flexible Inv Emg Mkt 2060% 4085% North America UK All Cos UK Equity UK Small Inc Cap FIGURE 8 AVERAGE SALES BY SECTOR 5 YEARS RETURNS ( M) , Corp Strat. Asia Pac ex Jap Europe ex UK Flexible Inv Emg Mkt 2060% 4085% North America UK All Cos UK Equity UK Small Inc Cap FIGURE 9 AVERAGE SALES BY SECTOR 10 YEARS RETURNS ( M) , Corp Strat. Asia Pac ex Jap Europe ex UK Flexible Inv Emg Mkt 2060% 4085% North America UK All Cos UK Equity UK Small Inc Cap 6

7 STERLING CORPORATE BOND The findings for this sector (figures 10 to 13) are interesting in the degree to which aggregate sales for poorer performing funds most notably those ranked in the second quartile have regularly pushed into positive territory and look to be detracting from sales for those funds with first quartile performance. On average, funds with second quartile performance have inflows through 1, 3 and even 5year rolling periods. This pattern is partly the result of the significant rise in sales of funds in this sector from the fourth quarter of 8 to the third quarter of 9, as the reverberations of the financial crisis were first being felt. It does look as though the managers that were most favoured in this period were those with at least 10 years experience, i.e. a proven track record (even if such a track record was not first quartile over shorter periods). REUTERS/JOSE MANUEL RIBEIRO MIXED INVESTMENT 2060% SHARES This sector (figures 14 to 17) has already been mentioned above, but the historical evolution of sales provides some valuable colour to the headline averages. In particular one can see that between 2 and the end of 7 outflows from any quartile of funds were negligible, although the financial crisis has changed this somewhat for those with poorer 3year or 5year returns. But even more recently inflows to better performing funds typically outweigh outflows from other funds. Even more striking is the trend established when looking at sales related to funds with 1year track records. Here, in the vast majority of quarters assessed these funds enjoyed inflows irrespective of their performance, to the extent that often first quartile performing funds appear as also rans in terms of net sales. This contrasts with the data for 10year performance periods where, despite poorer performers looking to be largely immune from outflows, first quartile performers dominate sales activity. UK ALL COMPANIES The prevailing mood since 7 has been very much against UK equity investment: in 56% (23 out of 41) of the quarterly periods analysed in this report (figures 18 to 21) the sector suffered outflows. As a result even aggregate sales for first quartile funds have struggled to make it into positive territory. In this context it is little wonder that funds launched in this sector in recent years have been fighting a losing battle to gather assets, and so sometimes closed, regardless of whether their performance has been any good. The Neptune UK Alpha fund, which announced plans to close in October, despite above average returns, comes to mind. As a result first quartile performance looks to serve more of a defensive purpose stemming outflows rather than generating inflows albeit that this still reveals a clear distinction between the best and poorer performers. Having said this, when assessing 5year and especially 10year performance in particular, the battlefield looks grim indeed. For the latter, in only four quarters over the past eight year (i.e. 32 quarters) did funds with 10year track records see aggregate inflows (irrespective of their performance). 7

8 FIGURE 10 CORPORATE BOND 1 YEAR RETURNS ( M) 5,000 4,000 3, FIGURE 11 CORPORATE BOND 3 YEARS RETURNS ( M) 5,000 4,000 3, FIGURE 12 CORPORATE BOND 5 YEARS RETURNS ( M) 5,000 4,000 3, FIGURE 13 CORPORATE BOND 10 YEARS RETURNS ( M) 5,000 4,000 3,000 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q

9 FIGURE 14 MIXED INVESTMENT 2060% SHARES 1 YEAR RETURNS ( M) 1, 1, FIGURE 15 MIXED INVESTMENT 2060% SHARES 3 YEARS RETURNS ( M) 1, 1, FIGURE 16 MIXED INVESTMENT 2060% SHARES 5 YEARS RETURNS ( M) 1, 1, FIGURE 17 MIXED INVESTMENT 2060% SHARES 10 YEARS RETURNS ( M) 1, 1, 800 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q

10 FIGURE 18 UK ALL COMPANIES 1 YEAR RETURNS ( M) 3,000 4,000 5, FIGURE 19 UK ALL COMPANIES 3 YEARS RETURNS ( M) 3,000 4,000 5, FIGURE 20 UK ALL COMPANIES 5 YEARS RETURNS ( M) 3,000 4,000 5, FIGURE 21 UK ALL COMPANIES 10 YEARS RETURNS ( M) 3,000 4,000 5,000 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q

11 CORRELATION It is possible to go beyond an examination of relative inflows to funds in different performance quartiles, and instead take this a step further to see whether there is a specific correlation between all performance quartiles and sales, i.e. whether sales activity worsens as performance continues to decline. To explore this, the whole universe of funds assessed in this report was analysed and a correlation coefficient between net sales and performance quartiles was calculated for every quarterly period. The average correlation coefficient for each quarter and for the different performance periods (1, 3, 5 and 10 years) are presented in figure 22. In order to summarise this chart, an average of the coefficients was calculated. For 1year rolling periods the average correlation is 0.84 (median of 0.91) and for 3year periods it is 0.86 (median of 0.90). In 26 out of 41 periods (63% of the time) both 1year and 3year correlations are at least In other words the correlation between sales and shorter term performance looks to be strong most of the time, with exceptions most likely caused by investors redeeming due to wider market conditions, most notably in the third quarter of 7. As elsewhere in the report, the relationship between sales and performance weakens as the periods assessed are extended to 5 years and beyond, with an average correlation coefficient of 0.80 for 5year rolling performance. This correlation falls away completely for 10year returns, as the chart illustrates, with the relationship disappearing for most of the quarters since mid9. FIGURE 22 CORRELATION BETWEEN PERFORMANCE QUARTILE AND SALES

12 CONCLUSIONS The findings in this report are clear in that generally money flows to those funds with first quartile performance, although this relationship generally deteriorates when looking at 5year returns and deteriorates further for 10year returns. One can certainly contend that these findings reveal a properly functioning industry: money flows to those funds that have performed well. This is also preferable to the situation too often found in continental Europe over the past decade, where new fund launches (i.e. that do not have past performance 3 ) have generally dominated sales activity. 4 While such a contention runs against the warnings that accompany promotions based on funds track records past performance is not a guide to future returns one cannot escape the fact that fund managers who are able to build up an impressive history are clearly in a powerful position when making their case to prospective investors or their financial advisers. Some investors are taking advantage of a manager s winning streak or, more precisely, the shortterm persistence in fund performance. Furthermore, just because sales are greater for first quartile funds, this does not mean that those funds attracting the greatest volumes do not also exhibit other characteristics that warrant investment. This is all the more the case when bearing in mind that there is likely to be wide variations in inflows for funds within the first performance quartile. 5 The difference in fund sales between those with good shorter performance periods (1 and 3years) compared to longer (5 and 10years) periods also suggests that some investors are taking advantage of a manager s winning streak or, more precisely, the shortterm persistence in fund performance. Evidence for the phenomenon of shortterm persistence has been found by various academics, including Bernhardt et al (3), Bollen and Busse (4), Carhart (1997), Hendricks et al (1993) and Zheng (1998). 6 While definitions of shortterm used in these papers vary, Wermers (3) certainly goes further when he concludes that outperformers continue to outperform other funds for at least two years following the ranking year. In such a situation it is certainly possible that investors, or their advisers, are effectively buying and selling perceived alpha generated by funds in an effort to stay ahead of benchmarks. Needless to say it is particularly difficult to determine the extent to which this takes place in practice. 3 At least not performance that an investor could have experienced. 4 See Lipper, New products shed light on distribution (2011) 5 See Lipper, Does the winner take it all? (2012) 6 Smart Fund Managers? Stupid Money? (D.Bernhardt, R.Davies, H.Westbrook, 3) ShortTerm Persistence in Mutual Fund Performance (N.Bollen, J.Busse, 4) On Persistence in Mutual Fund Performance (M.Carhart, 1997) Hot Hands in Mutual Funds (D.Hendricks, J.Patel, R.Zeckhauser, 1993) Is Money Really Smart? (R.Wermers, 3) Is Money Smart? (Lu Zheng, 1998) 12

13 Certainly there is much use of quant screens of some kind by fund selectors hardly surprising given the thousands of funds available although the potential consequences of this approach were highlighted by Marcus Brookes, Head of MultiManager at Cazenove Capital recently. Brookes was quoted as saying, A lot of people doing this are buying high and if it has just outperformed maybe it is because it is a highly cyclical growth fund or a value fund and that is why it has done well in the previous period. It also means you are discounting threequarters of the sector. 7 The Hargreaves Lansdown Wealth 150 list of the independent financial service provider s favourite funds was launched in November 3 when there were around unit trusts and OEICs domiciled in the UK. Today this number stands at around 2,500 funds. Interestingly, though, rather than rising by a similar 25%, the Wealth 150 is actually 25% below capacity at 112 funds (although it has risen to 165 funds in the past), partly the result of a better quant screening process. 8 REUTERS/YUSUF AHMAD This report does not mean that a fund manager has to be shorttermist, but the sales patterns identified will inevitably put pressure on a manager s recent track record if a fund wants to achieve significant inflows. 7 Portfolio Adviser, Fund buyers are quantitative lemmings, says Brookes (13 Sep 2012) 8 Investment Week, Hargreaves Wealth 150 falls to 112 funds (30 Oct 2012) 13

14 METHODOLOGY Funds universe. For comparison purposes, this study looked at funds in thirteen IMA sectors, namely: Sterling Corporate, Sterling Strategic, Flexible Investment, Investment 2060% Shares, Investment 4085% Shares, Asia Pacific ex Japan, Europe ex UK,, Emerging Markets, North America, UK All Companies, UK Equity Income and UK Smaller Companies. Only UKdomiciled funds were examined to provide as good a view as possible of the buying habits of UK investors. Performance. This is calculated as the total return with dividends reinvested on exdividend date, in GBP for the primary share class of each fund. REUTERS/PAUL HACKETT Rolling periods. This study analysed rolling periods of performance, i.e. every three months the previous 1year, 3year, 5year and 10year returns were assessed and presented as quartiles. In this way the findings do not simply reflect a snapshot of one period. Quartiles. All funds performance is ranked from highest to lowest for each period assessed. 25% of the funds in a given period that have the best performance are ranked first quartile, the next best 25% are ranked second quartile, the next best 25% are ranked third quartile, and the 25% of funds with the worst performance are ranked fourth quartile. Sales. This reflects the net sales (i.e. gross sales less redemptions) each quarter for each fund assessed (i.e. all share classes, not just the primary class) in GBP. The term flows is used interchangeably with sales in this report. Correlation coefficient. Some use is made of the correlation coefficient in this report. This is used to measure the degree to which performance rankings (from first to fourth quartile) are linked to net sales generated in each quarter. The equation used for this calculation is: Correl (X,Y) = (xx)(yy) (xx) 2 (yy) 2 14