Managed funds failed financial crisis

Research from Royal Bank of Scotland suggests that cautious and balanced managed funds were slow to respond to the volatility unleashed by the recent global financial crisis.

Analysis of Morningstar data shows that between 31 October 2007 and 28 February 2009 – when equity markets fell by around 50% in the US and in Europe – more than 80% of the largest funds in the UK in the cautious managed sector adjusted their equity exposure by just 20% or less in absolute terms. Half of the funds adjusted their equity exposure by less than 10%. This was at a time when the annual volatility of the funds soared from 4.2% to 13.5%.

The research also showed that taking the cautious and balanced managed sectors as a whole over the period, more than 80% of the largest funds changed their equity allocation by no more than 20% in absolute terms. Two-fifths (40%) of the funds altered their equity exposure by less than 10%. Over this period the volatility of the funds in these sectors went from 5.2% to 16.6%.

Research commissioned by RBS also shows that nearly one in seven investors (14%) who had equity investments at the time of the market crash in 2008 sold at least some of their investments.

Of those who sold, 56% sold up to £10,000, 17% sold between £10,001 and £20,000, 10% sold between £20,001 and £100,000, and 3% sold more than £100,000. One in 10 (10%) preferred not to answer and 5% did not know.

Evidence suggests that simply limiting equity exposure to a set limit throughout the market cycle is not the solution to controlling volatility. Even those cautious funds with a 30% or less equity holding had an average maximum drawdown of 16.8% over the three years to 31 December 2010.

Importantly, analysis by RBS also shows that there was a very strong link between the maximum peak to trough drawdown (losses) of cautious managed funds and their annualised volatility. Analysis of the sector over the last five years shows that the correlation between annualised volatility and maximum drawdown (i.e. the relationship of how closely they behave in relation to each other) was 0.844 over that period.

In 2008/2009 the average volatility of the top 10 cautious managed funds (by AUM) doubled compared to 2006/2007 with some funds showing an annualised volatility of over 16%.

Zak de Mariveles, managing director, Global Banking & Markets, RBS said: “Unfortunately many investors react emotionally to their investments falling and often tend to sell some of their investments at times of significant market uncertainty, potentially limiting their returns or generating a real loss of capital.”

“If fund (managers) were to react more dynamically to such periods of high volatility with an aim of limiting losses, investors should feel less nervous and refrain from making decisions that may not be in their longer term interest. Unfortunately, our research shows that many funds do not change their asset allocation significantly during volatile times.

“Our research also suggests that limiting volatility is not simply achieved by having a fixed limit on equities for all seasons. It is more about having a dynamic strategy in place for knowing when to significantly increase and decrease exposure to equities and other asset classes throughout the investment cycle.”

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