Funds Premier League: February review

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The advent of a new calendar year coupled with the approach of the so-called "ISA season", when the annual tax-efficient allowance nears its expiry, is a signal for many investors to spring clean their portfolios and consider which funds to buy. But it is difficult to decide which funds are worthy of your own-earned money.

Spotting fund managers' faces plastered on billboards or advertisements telling you to invest in the new big thing is an unwise strategy on which to base your investment fund buying habits. We are also often told that "past performance is not a useful indicator of future performance".

So how can investors determine which fund may outperform in the future and deserves a place in their stocks and shares ISA?

The Money Observer Fund Manager Premier League is a useful guide in such matters. There is no point discovering that a fund has given its investors an enormous return in the latest month and duly invest in it, as it could well have been a fluke and actually be haemorrhaging money over the longer term. With this in mind, our league looks at 11 popular sectors for open-ended funds, and calculates the top performers, based on consistent high returns. It's the consistent bit that is the essential part. A fund manager that routinely delivers a high return in relation to their peers should have the skill to continue doing so in the future.

The league is measured every three months across three discrete one-year timeframes. If a manager slips into the third or fourth quartile in the most recent year, they are ejected.

They are then replaced with the manager at the top of that sector (in terms of first-quartile returns, and a high three-year return). There are a few more rules: the manager must also have been at the helm for at least three years and be managing at least £10 million of money.

In this update there are two funds that have slipped into the third quartile over the past 12 months. JPMorgan US Equity Income, managed by Clare Hart, has fallen into 61st place out of 94 North America funds. Stock selection in the IT and financial sectors held the fund back last year. For example, it did not have any exposure to Google (GOOG), and not enough exposure to Apple (AAPL). The JPMorgan fund was also negatively impacted by T Rowe Price and a lack of exposure to JPMorgan Chase (JPM) and Citigroup (C), both of which performed well last autumn.

To replace the struggling US fund, the Greenwich fund is top of the leaderboard. Stephen Memishian has managed this fund since it launched in 2004. However, it is a tiddler, just £3 million in size, so it does not qualify for the Premier League.

In second place is GAM North American Growth. The fund ranked in the second quartile for the most recent year but has two shiny sets of first-quartile performance for the years preceding it. It also has the second-best three-year return in the sector, at 51%.

The fund has been managed by Gordon Grender since its launch in 1985. Grender looks for the best US and Canadian companies (although he currently doesn't hold any Canadian stocks), regardless of what sector they're in. He likes well-managed and undervalued companies, and has had a defensive allocation to cash for some time. He comments: "I follow a different approach and do not pay any regard to index weightings. I just try to find interesting companies to hold for the longer term."

Indeed, in terms of index weightings the £141 million GAM fund has less than 1% in the IT sector (compared to the S&P 500, which has 19% in IT companies). Grender notes: "I find technology companies very difficult to value."

Conversely, the fund's largest exposure is to the consumer discretionary sector, at 24% (the S&P 500 has 11%). Its biggest holding is Conn's, a US home retailer selling furniture and electronics, with a sideline in insurance, distribution and financing. Its share price has rocketed by 140% over the past 12 months. The next two largest holdings are Huntsman (HUN), a global chemicals manufacturer, and WR Berkley (WRB), an insurer. Huntsman is another success story for the fund, rising 84% over the past year.

Grender believes the US economy is in better shape than most others. He thinks the agricultural and energy sectors look interesting and says the main problem for the US is the inability of politicians to control spending.

The other fund leaving the Premier League is Fidelity MoneyBuilder Balanced, managed by Michael Clark and Ian Spreadbury. Like the JPMorgan fund, it has fallen into the third quartile for the most recent year.

The Fidelity managers say part of the reason it didn't perform as well as its peers is due to the equity/bond split in the fund. The MoneyBuilder Balanced fund has a higher allocation to bonds (24% of the fund) than the average allocation in the 10 best-performing funds in the mixed investment 40-85% shares sector (15%). "The return on the FTSE Gilts All Stocks index was just 0.36% compared with 15.8% for the FTSE All-Share index over 2012. This allocation split provides some explanation as to why the fund had lower returns compared with its peer group," the managers say.

"Perhaps most importantly, it is worth noting that the volatility of the Fidelity MoneyBuilder Balanced fund is very low for the sector and therefore on a risk-adjusted basis, the fund would have been in the first quartile in 2012."

Within the fund's equity holdings, there were a couple of defensive stocks in 2012 that detracted from performance. Pennon Group (PNN), which was a large overweight position for the fund, issued a profit warning for its waste division in the third quarter of last year. Another detractor was GlaxoSmithKline (GSK), which failed to perform up to expectations. However, Clark says it does not alter his long-term view of Glaxo "as the proven revenue streams and strong dividends should continue to perform well in future".

Looking at the rest of our Premier League members, special mention should be given to three funds that continue to post three consecutive sets of first-quartile rankings as well as retaining their top spot in their sectors. Well done to Newton Asian Income, Threadneedle European Select and Investec UK Smaller Companies.

The Investec fund has also delivered the second-biggest three-year return to its investors, at 62%. Congratulations to Liontrust Special Situations for dishing out the fattest three-year return though, at 73%.

The funds in the league range from the rather small to the absolutely gigantic. Unicorn UK Income, which launched in 2004, is slowly winning over investors with its sterling track record and has built up assets to around £70 million. But this is nothing compared to M&G Global Dividend, Newton Global Higher Income, Newton Asian Income and Aberdeen Emerging Markets, which each have billion-pound portfolios.

Stuart Rhodes looks after an enormous £4.1 billion in the M&G fund, making it the UK's largest global income fund. Over at Aberdeen Asset Management, Devan Kaloo manages £3.6 billion in its emerging markets fund. In February 2012, Aberdeen asked distributors to no longer promote the fund to investors, to try and slow down the rate at which investors were pouring money into the top-performing fund. Aberdeen is considering again how to stem flows after experiencing a flood of money in the last quarter of 2012. But as Money Observer went to press, the fund is still fully open to private investors and the minimum investment is £500.

Kaloo says his success at achieving first-quartile returns comes from focusing on high-quality companies, and last year re-rating of specific markets in which the fund had significant exposure also helped. "Over the course of 2011 stockmarkets in Turkey, Mexico and India sold off on inflation, links to the US economy and political paralysis concerns respectively. Convinced about the quality of our holdings in these markets and their positive longer-term outlook, we added to our positions there. In 2012 investor concerns dissipated and our holdings and the markets overall re-rated, adding significantly to our fund's relative performance," Kaloo explains.

Going into 2013, the fund remains underweight in China, Taiwan and Korea, as Kaloo "struggles to find companies that meet our quality criteria" in those countries. He adds: "We are overweight Latin America where we find opportunities in Brazil and Mexico."

This year could be a volatile one for equity markets, according to Kaloo. He says uncertainty over the US fiscal cliff and long-term structural flaws in certain European economies are headwinds for the emerging markets. The emerging markets are increasingly facing growing challenges of their own too. Kaloo names new leadership in China, economic stimuli in Brazil and India and geopolitical tension in the Middle East and Asia as issues he'll be keeping an eye on.

"Yet our companies in emerging markets remain in good shape, valuations overall are not expensive and there is the prospect that investor sentiment could turn positive if global concerns dissipate and emerging markets' economic and corporate profits recover in the first half of 2013, though this may be difficult to sustain in the second half of the year given the still anaemic outlook for global growth and significant headwinds mentioned," he comments.

In terms of the outlook closer to home, John McClure, manager of the small but very successful Unicorn UK Income fund, shares his sentiment on the UK. He says lots of companies are looking very strong. "I'm quite positive this year. I would be very surprised if any UK firms cut their dividends this year. I also think there will be quite a bit of corporate activity."

McClure recently bought Pendragon (PDG), a car retailer. "I'm not that negative on the UK domestic customer. I'm very negative on UK housebuilders, as interest rates will go up at some time, and I'm negative on general construction. But there will be pockets of spending, such as on cars. Your car runs out, but your house doesn't. I'm also avoiding furniture and carpet companies," he says.

Investors looking for a UK equity fund can also look at our table of perfect score funds (above), which reveals other funds that have achieved three years of consecutive top-quartile returns. Many of those with the largest three-year return are focused on the UK, for example Neptune UK Mid Cap, CF Lindsell Train UK Equity, Unicorn Outstanding British Companies and Baillie Gifford British Smaller Companies.

The table also shows some of the best funds in sectors that our Premier League doesn't cover. For example, using our formula, the most-consistent high-performing Japan fund is CF Morant Wright Nippon Yield, with a juicy 32% gain over the past three years.