Should investors avoid the most popular funds?

When there are a couple of thousand funds to choose from, do-it-yourself investors face an overwhelming amount of choice; but help is at hand to condense the list down to a shortlist. 

At Money Observer, for example, we help readers focus their sights towards what we regarded as the superior options. In our annual fund directory Your Fund Choices 2018, available at leading newsagents from 8 February 2018, we provide full details of the 199 Rated Funds and investment trusts selected by the Money Observer team of experts. We also include a selection of 63 of the best passive funds and ETFs.

-Your Fund Choices 2018: how to order 

Moreover, various brokers, including Hargreaves Lansdown and The Share Centre, have their own recommended fund lists, while in addition most platforms also keep tabs on the most popular investments among their clientele. 

Money Observer regularly crunches the numbers to the name the most-bought funds and investment trusts each month among users of Interactive Investor, our sister website. 

But while there’s a certain comfort factor behind following the crowd, when it comes to funds, size matters – a point acknowledged by Adrian Gosden, who until last summer was co-manager of the £6.3 billion Artemis Income fund, a position he had held for nearly 14 years. 

Gosden now runs the GAM UK Equity Income fund, which has just £21 million in assets under management, having launched last October. He is therefore well placed to spell out the challenges faced by fund managers who run billions of pounds of investors’ money. 

A point often made by fund analysts is that the bigger a fund becomes, the more difficult it is to move the needle and outperform peers and indeed the wider market. In contrast smaller funds, which are more nimble and flexible, have a structural advantage. 

‘I wouldn’t say it is harder to outperform running a big fund; it is just a different job,’ says Gosden. ‘For instance, when wanting to buy or sell a share you have to plan your entry and exits in a completely different way – you have to enter and leave earlier than you would like, whereas with my new fund, if want to sell one of my holdings I can do so tomorrow.’ 

Moreover, Gosden points out that running a smaller fund means he has more flexibility to invest in smaller-sized businesses. His new fund has half the portfolio in large caps, 35 per cent in mid cap names and 15 per cent in smaller companies.  

In contrast, larger funds are more constrained. Big funds need to own a significant portion of a smaller company for it to be a meaningful position in the portfolio. 

The biggest problem for big funds, however, arises when they become forced sellers in order to meet redemptions. Quite often investors rush to the exits when performance takes a turn for the worse, but this in itself can create a vicious circle. Gosden points out that fund managers who are having to return cash to investors ‘are selling their own portfolios’. 

He adds: ‘Running a big fund also means having bigger stakes in companies, and you can end up being the biggest shareholder. If you want to sell, the market can work out that the biggest shareholder is selling [and that causes the share price to fall as other investors sell too].’ 

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