Back in the Nineties, I bought a fund called Jupiter Income. I’m sure many of you bought it, too. It was at the top of the performance tables by some distance.
It continued to fly for a few years, until the manager and market conditions changed. But it delivered a handsome profit before I sold it.
I bought purely on past performance. Yet, as retail investors, we have it hammered into us that we should not take too much notice of this.
The City regulator says that sales material must contain ‘a prominent warning that the figures refer to the past and that past performance is not a reliable indicator of future results’.
Sparkling: About a year ago tonic water firm Fever-Tree shares could be bought for less than £20. It is now trading at £33.46 per share
That’s fair enough. But in almost every other walk of life, we use past performance as an indicator of what’s to come.
When it comes to individual shares, there is plenty of research suggesting so-called momentum investing — backing investments that are already on the rise — can reap rewards.
Let’s take tonic water firm Fever-Tree (with a large shot of gin, if you prefer). I was chatting to an investment adviser about a year ago, when the shares could be bought for less than £20.
He said he would wait and buy it for his clients if it showed any weakness. It is now trading at £33.46 per share.
Well, hindsight is marvellous, but I suspect he now wishes he’d bought, rather than waiting.
The idea of momentum investing seriously upsets some analysts because it suggests that markets work on emotion, rather than efficiency.
And that emotion can work the other way. I hold a small number of shares in the unloved Lloyds Banking Group, which I bought for around 23p each in 2011, after emotion pushed them ever downward.
They delivered a reasonably swift return but, for the past few years, have seemed stuck in the doldrums and now trade at around 61p.
With the negative feelings towards the banking sector, I doubt they will be going anywhere soon, but at least they pay a dividend of around 5 per cent.
So could momentum investing work with investment funds? After all, a fund is just a basket of shares and, if that basket has momentum, isn’t it reasonable to go with it?
Brian Dennehy, of FundExpert, bases his investment philosophy on momentum, while factoring in risk.
Brian Dennehy, of FundExpert, bases his investment philosophy on momentum
He homes in on funds with top performance over the previous six months. ‘Our research, since 1994, suggests that most funds that hit a sweet spot maintain it for about a year,’ he says.
Getting in earlier is not an option. ‘We looked at funds that had outperformed for three months, but following them produced far more volatile results,’ he adds.
The key thing is to watch performance and, as soon as it drops, be prepared to switch to an alternative. That means conducting a thorough review every six months.
Mr Dennehy went back to 1994, picking just the top three funds from the UK All Companies sector every six months, then swapping them out for new ones as performance lagged.
He got an average annual return of 13.01 per cent, compared with 7.4 per cent for the average UK All Companies fund and 7 per cent in an index tracker.
How risky is it? The greatest single monthly loss was around 15.5 per cent, about the same as that on the average All Companies fund, but more than the 12.9 per cent for a tracker.
Chopping and changing funds goes against everything we are told as investors.
But then, it is hardly in a fund manager’s interest to say: ‘Our fund is utter pants — why not try one that’s doing better?’
So perhaps we should concentrate on time in the market, rather than time-served loyalty to a fund. Regularly switching funds used to be expensive. And it is still important to be wary of those with a sneaky buying charge, called a bid/offer spread.
Also, if you trade investment trusts, there will be a broker’s dealing charge and stamp duty because these type of funds operate as shares themselves.
Buying and selling charges from a financial adviser or the platform holding the investments are also an issue.
I’m curious about the momentum principle on funds. I already hold a number that appear on the FundExpert five-star list, including Lindsell Train Global Equity, CF Odey Opus, Fundsmith Equity, Standard Life UK Smaller Companies, Artemis Income and Baillie Gifford Managed.
I can compare these against two that get just one star, Vanguard Equity and HSBC 250. Both are trackers.
I’ll also be setting up two virtual portfolios based on the FundExpert-favoured funds in two sectors.
The first is World Excluding UK. This features two Legg Mason funds: IF Japan Equity Hedged and Japan Equity plus Baillie Gifford American. This feels awfully weighted to Japan for my tastes.
The second is a UK-only portfolio of Jupiter Smaller Companies, Schroder Income and TM Cavendish Aim.
I’ll take a look at how these have performed against some benchmarks in a few months’ time and report back.