Bestinvest’s dog ratings are based solely on statistical criteria relating to a fund’s past performance. Here we explain the methodology.
Over the last couple of decades the fund management industry has become increasingly competitive. Markets trade globally around the clock, information is available within seconds and large companies in particular are analysed in detail by scores of analysts at banks, brokers and fund managers all of whom are trying to find an edge. It is unsurprising then that fund managers need to be really good just to be average. If you are going to invest in actively managed funds, you need to be very selective in choosing those managers with the skill to deliver superior returns that justify their fees. Most fund managers do not achieve this over the long term.
Spot the Dog is focused on identifying those funds that warrant special attention because they have performed particularly badly compared to their benchmark over a reasonable time period and consistently so.
- We analyse UK domiciled and regulated open-ended investment companies (OEICs) and unit trusts that invest predominantly in equities as this is where the greatest differentials in performance between funds occurs.
- We only consider funds that have share classes that are open to retail investors, stripping out those only accessible to institutional investors.
- We do not include investment trusts or investment companies as their share price performance may not reflect the net asset value performance delivered by the fund manager due to discounts or premiums. We do however research and rate investment trusts and we make our research available to investors.
- We exclude funds of funds/multi-manager funds because of the absence of like-for-like benchmarks.
Establishing a benchmark
To assess the performance of a fund, we need to compare it with a suitable benchmark. In most cases this will be an index that represents the overall movements in the market that the fund operates in. For example, for most UK equity funds the comparison will be against the FTSE All-Share Index but for more specialist funds, such as those that focus on smaller companies, we allocate a more appropriate index. We try to identify whether the performance of the fund after charges has added or detracted from the returns delivered by general movements in the benchmark. Every fund group allocates a benchmark to each of their funds, usually a market index but sometimes a peer group of competitor funds or a measure such as a target return above inflation or interest rates is used. In most cases we will use the benchmark set by the fund group but we will occasionally override this. For example, we think it is wrong for a fund that has a remit to focus on FTSE 250 index stocks to be compared with the broader FTSE All-Share index.
Definition of a dog fund
We apply two filters to identify dog funds. First we filter the fund universe to identify those that have failed to beat their benchmark over three consecutive 12-month periods. This filter is used to highlight those funds that have consistently underperformed and to strip out those that may simply have had a short-run of bad luck. However, if this was the only filter it would generate a huge list of funds including all index trackers as these are bound to regularly underperform at least slightly due to their charges. We therefore apply a second filter: the fund must have underperformed its benchmark by
10% or more over the entire three-year period of analysis.