Bad dogs: hundreds of investment funds are underperforming their benchmark – is it time to sell?

Investors with low or no exposure to soaring artificial intelligence-themed stocks and the energy sector are losing out as hundreds of active fund managers struggle to  beat their benchmark.

It has been a good time to invest in recent months as stock markets such as the FTSE 100 and S&P 500 have hit record levels, but much of the rise has come from booming technology and energy stocks. That means if you don’t have money in these sectors, you could be missing out.

Investment platform Bestinvest’s latest Spot the Dog report found 137 equity investment funds holding £53.42 billion of investors’ wealth have consistently underperformed their relevant market benchmarks over the past three years as of the end of June 2024.

The figure is at least a 9% fall on the 151 ‘horrid hounds’ and a 44% drop on the £95.26bn in assets, featured in the previous Spot the Dog report in March 2024. But it remains significantly higher than the 56 funds flagged only a year ago.

What is a dog fund?

Active fund managers are supposed to earn their money by outperforming their index and picking the top stocks over the long-term. If they aren’t doing this for you then it may be worth just paying for an index fund.

Bestinvest’s Spot the Dog report, released twice a year, aims to highlight the serial underperformers. It focuses on funds that have failed to beat their benchmark over three consecutive 12-month periods by 5% or more. These poor performers earn the label of dog funds.

The investment platform insists this isn’t a “sell list” but should prompt further investigation.

The biggest dog funds

The technology sector is dominating the stock market at the moment, with a big concentration on artificial intelligence and the Magnificent 7 in the US. Investors with money in funds not fully exposed to this handful of companies have struggled to keep pace. This has hit global equity funds the most, with 44 howlers sent to the kennels – a slight improvement on the 51 featured at the start of the year.

The poor performance of global equity funds has been compounded by the rising value of energy stocks. Over the three-year period covered in the latest report, the MSCI World Energy Index delivered a total return in GBP of 98%, well ahead of the MSCI World Index total return of 28%.

But a third of the global funds featured on the list focus on sustainable investing and therefore did not benefit from the surge in oil and gas-related shares during this period.

Environmental, social and governance (ESG)-focused funds also make up a fifth of the Spot the Dog tally, Bestinvest says.

The tally of UK equity funds, including funds in the UK All Companies, UK Equity Income and UK Smaller Companies sectors, came in at 44, a similar level to the last edition in March 2023 but up from 12 in August 2023.

Around a quarter of underperforming UK mutts are comprised of ethical and sustainable funds due to their lack of exposure to the UK market’s sizeable energy and commodities sectors, according to the report.

One area of concern highlighted by the report is the size of the big beasts featuring in the pack. Ten “Great-Dane sized funds” – each more than £1 billion in size – account for £26.81 billion and therefore represent half of the lagging assets.

Should you put a dog fund down?

There are plenty of reasons a fund can perform badly. Market conditions may not benefit its strategy or there could have been a management change. It is always worth checking how a fund is performing and the steps a manager is taking to improve.

Performance can also change, especially over the long term so check if you are still happy with the direction of a fund and if it fits into your overall financial plan.

For example, two of Britain’s most prominent and widely held Terry Smith’s Fundsmith Equity and Nick Train’s WS Lindsell Train UK Equity were included in the March report but have performed well enough to drop out this time around.

“With many fund managers failing to achieve this over the long run, the report acts as a guide to encourage investors to keep a closer watch on how their investments are performing to assess what action, if any, is required and when,” says Jason Hollands, managing director of Bestinvest.

“Funds can stumble for a myriad of different reasons – from poor decision making or a run of bad luck to instability in the team or because the fund has a style or process no longer favoured by recent market trends.

“Identifying whether a fund is struggling with short-term challenges that will later pass, or more deep-rooted issues with long-term consequences is vital for investors considering whether to remove an investment from their portfolio.”