an analysis of the total number of available funds according to geography and sector, shows popularity is inverse to performance
Last month, I described how unit trust investors' decisions on when to invest could be used profitably to do the opposite. I calculated that their poor market timing in their home market had cost an average 4.4% under-performance per year for the past 15 years. This month, I will analyse if their decisions on where to invest can similarly be used profitably to do the opposite.
Official government statistics were very helpful for last month's analysis, but the Office of National Statistics does not produce sufficiently detailed information for this task. Fortunately, Standard & Poor's funds database contains historical records on the various types of equity fund available to UK investors over the past decade. As there are currently some 3,750 funds, the numbers are large enough to be statistically meaningful for sub-sets by at least the major mandates.
The decision to market or close a fund is a major investment for any fund management house. Therefore, this analysis is also a verdict of the investment skills of the firms, as distinct from their individual fund managers, who were shown last month to not be responsible for the poor market timing of their unit trust holders.
Due to the five-fold increase in funds available over this period, it is more useful to analyse changes in popularity for different types of fund, as shown in the three graphs. These segment the market in different ways:
• In terms of geography, each region is shown as a proportion of the entire funds universe after eliminating overlapping sectors, as the majority of mandates are still regional.
• In terms of economic activity, each sector is shown as a proportion of all sector mandates, as this is a small but rapidly growing part of the industry.
• In terms of market capitalisation, small-cap funds are shown as a proportion of funds investing in each region. These funds are limited to the bottom 10% of market capitalisation, so they are also a minority, but a long-standing one.
These show there is a close relationship between changes in popularity of funds and relative stock market performance. That makes popularity an effective reverse indicator for tactical asset allocation. Likely implications for world markets are discussed below. On the whole, changes in popularity for funds are an effective reverse indicator, if only over the long term. However, is it fair to place responsibility on the fund management firms, as well as the customers, if the firms are simply supplying what they want? Unfortunately, the firms are nevertheless aiding and abetting their customer's poor asset allocation decisions through their marketing activities.
In addition, it can only be shortsightedness if firms actually close funds just as the mandate in question is about to revive in popularity. Such short-term cost saving is at the expense of long-term performance, which remains the most effective way to sell funds.
Based on size, the types of fund most at risk of closure are UK smaller companies, Latin America and all sectors except healthcare. However, as sector funds are a new fashion, firms are likely to be more patient. One should look for announcements of Latin American funds being merged into emerging markets and UK smaller companies being merged into European smaller companies funds, as classic reverse indicators.
Past performance: For a decade and a half, the US has been out-performing the rest of the world's markets, but since the millennium this has come to an end. The share of US funds has been steadily increasing in tandem and these now represent the single most popular regional mandate. The only pause in its rising popularity was in 1995, just after Wall Street experienced the only interruption to its outperformance.
Outlook: This good performance is based on consumer spending. That has generated large current account deficits, which are funded by ever-increasing debts to foreigners. What happens when it is pay-back time? Investors may suffer a double whammy, as the exchange rate falls and consumers become cautious.
Past performance: This has been the mirror image of the US, as it suffered from the burst bubble a decade ago, and the incompetence of its politicians in reflating their economy since then. Britain's unit trust industry has responded by steadily switching its interest away from Japanese funds
Outlook: This poor performance is based on consumer saving. What happens if Japan's politicians finally succeed in persuading them to spend more? Economic growth accelerates; the yen breaks out to new multi-year highs and the stock market soars. That may have begun to happen last month.
Past performance: Asia has been a long-term under-performer, hurt in the mid-1980s by the collapse in commodities, and in the late-1990s a second time by the currency crises. Rated a decade ago as the most exciting region for growth, this region has fallen to only third place in the popularity stakes.
Outlook: Asian savers have also been funding American spending. What happens when they stop worrying about Sars That looks like a case of third-time lucky for contrarians, delighted that lack of fund marketing hype means that bargains abound.
Europe ex UK
Past performance: European integration has helped the fringe countries to grow at the expense of the core. The net effect is that European shares have performed averagely for many years. Despite that, continental European funds have become increasingly popular.
Outlook: This may be inconclusive because Europe's popularity has more to do with our own expectations of integration than anything else, and the tax man's encouragement by changing PEP rules to include it. UK investors are anticipating the day when Europe may be our home market, as it already is for participants in the euro. What happens if that anticipation is premature? Nothing, because it relates to our perceptions rather than reality.
Past performance: The London stock market had out-performed world markets for many years since the crisis of British capitalism in 1974. For the whole period, UK equity funds have been much more popular than they deserve based on market capitalisation. Surprisingly, this popularity has increased despite the fact that London's out-performance ceased five years ago.
Outlook: This atypically astute behaviour may simply be due to greater confidence when playing at home, especially in difficult times. However, what happens if Britain continues to reflect developments in the US in diluted form? Investors may find themselves overweight in a modestly under-performing market, when the US consumer boom unravels.
Past performance: This minnow is the new convergence story and has recently been acting like it, having matured since the euphoric birth of capitalism. After initial enthusiasm for new funds, the sector's popularity has stabilised in recent years.
Outlook: This suggests that the good news is well known and adequately reflected in prices. What happens if investors decide to rush for the exit? That may seem unlikely now but they would find the exits are too narrow.
Past performance: This sector's performance peaked in the mid-1990s, and popularity for its funds peaked shortly afterwards. Battered by currency crises, both Latin American markets and funds are out of favour.
Outlook: After China and India, Brazil is the world's third biggest awakening giant and it has the advantage of the most under-valued currency of all three. This region also has the greatest exposure to raw materials. What happens when these three factors finally combine to create the long-awaited economic boom? Investors may miss the opportunity because it is below their radar screen.
Past performance: The millennium bubble has burst and IT stocks are enjoying a revival as recovery situations. TMT funds have driven the growth in sector funds, which have grown four times as fast as the industry. However, since the bubble burst, interest has widened to other sector funds.
Outlook: Technology funds are twice as popular as any other sector funds. This is out of all proportion to the weighting of TMT shares in stock market indices. If the story has already been so well sold, who is left still to discover it? Stale bulls - surely not.
Past performance: Since the commodities boom and bust in 1980, the sector dramatically under-performed until the Millennium. This was directly reflected by a similar decline in popularity for resources funds, such that availability reached a nadir at precisely the time when the greatest opportunity began.
Outlook: If the emerging markets lead the world into a new growth era, this will create a new resources boom, as consumers in developing countries buy their first durable goods. What happens if this generates demand for resources funds? Investment houses will rush to launch more, so fuelling the sector's stock market revival.
Past performance: This has been the most consistent growth sector for the past two decades, and that has been well reflected by surging numbers of health care funds.
Outlook: Despite soaring research budgets, major blockbusters are becoming rarer, so pharmaceutical companies are becoming more dependent on life-style drugs and high-priced low-volume niches. What happens if buyers decide that some prices are too high to pay for health?
Past performance: The sector has oscillated in and out of fashion with swings in interest rates. Meanwhile, the number of funds has rapidly increased and now ranks third in popularity.
Outlook: If the sector's performance is related to interest rate movements, what happens when interest rates start rising again? Surely it is likely to go out of fashion - at least temporarily.
Past performance: As the largest component of GDP, this sector's relative performance seldom strays far from average. Nevertheless, there are growing numbers of funds devoted both to the sector as a whole and niches within it.
Outlook: Inconclusive as the number of funds is still low compared with the sector's importance to the world's stock markets.
Past performance: This has been cyclical, reflecting changing levels of capacity utilisation in each region. Despite the increasing popularity of sector funds, there are very few available.
Outlook: If economic recovery is developing all round the world, this sector should outperform. Contrarians will be encouraged by the scarcity of suitable investment vehicles for doing so.
Past performance: This has been boring as the US dominates this sector and that responds to changes in bond yield. This is the least popular sector for funds.
Outlook: It seems likely to remain so, as it is boring, but not as boring as bonds themselves, which are more attractive to investors seeking safety.
Past performance: Despite different economic cycles, small-caps sometimes behave in a similar way all round the world. In recent years, they have been coming back into fashion worldwide.
Outlook: As the charts show, the popularity of small cap funds is on the whole a leveraged reaction to the popularity of their regions. However, the US is a major anomaly as US funds are increasingly popular.
Two global vehicles
'Further plug advice gap'
Must appoint separate CEOs and boards
Advisers do come out well
Will report to Mark Till