09 Jan Are there too many funds?
One of the more interesting unsolicited emails that hit my inbox in December was from a US fund manager (I subscribe to a website which is sponsored by various product providers but as some of the content is interesting, the occasional spam related to it is a reasonable price to pay even if I am unable to use their products).
In this instance, the fund being touted was an exchange traded fund (ETF) investing entirely in the pet care industry. Seven out of 10 US households, we are told, have pets. This is apparently more than the number of households with children. On this basis, there is supposedly a great opportunity to own the companies that cater for those pet owners as they are likely to deliver higher returns than the US stockmarket as a whole.
Yet I am willing to bet, having visited the US a few times, that 10 of those same 10 households also consume food. Does this make food companies a better investment? After all, when household budgets are under stress, pet ownership may be seen as a luxury. Even though in a serious emergency you can always eat Fido or Tiddles, they probably won’t sustain the family for long.
The urge to launch funds which focus on increasingly specialised segments of the market is nothing new however.
The Football Fund was launched amid much fanfare and in 1997 by the investment bank Singer & Friedlander. The head of one high profile adviser firm which promoted it claimed that,
“It’s on course to be very successful. It has come at the right time and captured people’s imagination.”
The launch raised £35 million from 20,000 investors but by 2002, when it was turned into a mainstream UK equity growth fund, its price had fallen by 50% despite the manager having widened the mandate to include other sport-related companies. Given the chronic weaknesses of the business model of football clubs, maybe the imagination here was more in the minds of the fund company’s marketing department than in those of investors.
Caught in the net
Framlington NetNet encompassed two funds. A unit trust was launched to retail investors in 1999, followed in 2000 by an investment trust version. The distinguishing feature of the latter was that in addition to the £60m in cash investments, there was a further £40m in bank debt. This gearing provided the managers with £100m of cash to invest, thus magnifying the returns to investors. In an ungeared fund, if the total portfolio increases by 10%, the investors’ £60m becomes £66m. However, with the geared version, the £100m invested becomes £110m. Allowing for the £40m debt, the investors would now have assets worth £70m, a return of more than 16%.
Of course, gearing, as anyone who found themselves in negative equity when UK house prices took a battering in the early 1990s can remember, is not a one-way street. If the value of the fund’s assets falls, the debt is still there and has to be offset against the now reduced value. Such was the fate of the NetNet investment trust. A year after its launch, the manager was forced to sell off most of what was left of the portfolio to repay the bank, leaving it valued at a barely viable £8m.
The unit trust fared slightly better, in that £1,000 invested at the start of March 2000 was worth a less impressive £237 by the end of the following March. Admittedly, the market as a whole suffered in what became known as the ‘dotcom crash’, yet a diversified global portfolio represented by the MSCI All Country World Index (with net dividends reinvested) would have turned the same £1,000 into £879 before charges (Source: Morningstar).
Both these funds shared the trait of being launched after a period of positive newsflow about their sectors, which made the task of the marketing teams easier when it came to telling a compelling story. In 1996, the price of some football club shares had risen an astonishing (in more ways than one) 500%. In the case of the technology sector, the US NASDAQ index rose by around 30% a year on average between October 1990 and February 2000 (and in the last 18 months of that period, it averaged over 100% a year), so it was perhaps surprising that the NetNet fund did not rake in more than it did. Ironically, by the time it was launched, the NASDAQ was already past its peak, so even the fund professionals didn’t get their timing right that time. For investors, buying when prices are at their historic high is not usually the best way to increase their wealth.
Yet they were not alone. In fact, in the 1990s when I was looking for a broadly diversified global market equity fund among the ETF universe, it was surprisingly hard to find one. There were (and indeed are) dozens of funds which we would still regard as pretty niche. They appeared to be aimed at the rare investor who was sufficiently knowledgeable as to the relative merits of healthcare, alternative energy or grains and when to switch between them. At that time, someone (like me) wanting a simple global equity fund was out of luck, although over a hundred global large company ETFs have been launched since 2003.
Of course the investor lacking in that sort of knowledge (a group which the evidence suggests includes almost everyone) could simply opt to buy multiple sector funds in order to ensure diversification. The drawback is that this entails them incurring more cost, more trading friction (as some of the underlying funds trade with each other) and much more admin and opportunities to pay tax. While owning a single global market fund for your equity exposure would be less interesting at dinner parties, it might just give you more time (and money) to get on with enjoying your life.