Five key takeaways from how funds and trusts performed in 2022

Kyle Caldwell examines the key trends that played out and lessons learnt for fund and trust investors in 2022.

The year 2022 will go down in the history books as one that many investors will want to forget. The change in the macroeconomic backdrop and a tightening of monetary policy caused havoc for stock markets, and by extension the performance of funds and investment trusts.

Below, is a run-through of five trends that played out for fund and trust investors.

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Fund sector returns show importance of long-term focus

Most funds lost money in 2022, with only six out of 58 fund sectors making a positive return. Just two produced returns ahead of inflation: commodity/natural resources and Latin America, with respective returns of 18.8% and 16.4%.

At such times, it is worth remembering that investing requires patience and a long-term focus. For funds, the rule of thumb is that investors should be willing to invest for at least five years to ride out the ebbs and flows that are par for the course of investing in the stock market.

On a five-year view, the picture is rosier, as 49 fund sectors have made a positive return. Of those 49 sectors, 12 have made returns above 20%, with technology, US and healthcare funds leading the way with returns of 65.3%, 61.6% and 61%. Over this period the average global equity fund has returned 38.7%. 

While it doesn’t sound very exciting, maintaining a balanced and well-diversified portfolio is the best way to ride out short-term market falls.

Investment styles go in and out of fashion

Interest rate rises in an attempt to tame inflation caused growth shares, particularly technology companies, to fall out of favour in 2022. Rising interest rates devalue the future earning expectations of growth stocks. As a result, valuations cool and the share prices re-price. 

Having enjoyed the tailwind of loose monetary policy for more than a decade, in the form of record low interest rates, the more challenging backdrop for growth funds and investment trusts has not gone unnoticed by investors. In response, growth mandates have become less popular among interactive investor customers.

In particular, several funds and investment trusts managed by Baillie Gifford have seen declines in both performance and popularity. Baillie Gifford, for example, looks to invest in the growth winners of the future.

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Investors have instead been turning to dividend-paying strategies to receive some ‘jam today’, which is being prioritised over the prospect of ‘jam tomorrow’.

The key thing to bear in mind with investment styles is that they do go in and out of fashion. To reduce the risk of being overly exposed to an investment style, it makes sense to choose funds that invest differently.

Limit exposure to specialist funds

When looking at the overall best and worst fund performers of 2022, specialist funds dominate. In particular, it was the second successive strong year of performance for energy funds, with TB Guinness Global Energy and Schroder ISF Global Energy returning 49.9% and 48.6%.

However, care needs to be taken with specialist funds as their performance blows hotter and colder than mainstream funds with broader remits. For instance, the two funds mentioned above were the worst performers in 2020, down 35.7% and 34.5%.

Other main examples of specialist funds are those investing in biotech or commodities.

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In my view, with such funds it is important not to simply ‘buy and hold’. Keep a close eye on performance and in good times consider banking profits ahead of sentiment swinging back the other way.

For investors who are willing to stomach the risk, such funds should form only a small part of a diversified portfolio.

Specialist funds are a potential good fit for a core and satellite strategy, where most of a portfolio (70% to 80% typically) is invested in developed market equity funds. The remainder, the satellite part, is where investors can add some spice by having exposure to more adventurous funds.

Smaller companies lose their shine when sentiment turns negative

One of the few bright spots of 2022 was the performance of the FTSE 100. In 2022, the UK’s premier index gained 0.9%, which was well ahead of a loss across the pond of 19.5% for the S&P 500 index.

The FTSE 100’s strong relative performance is a consequence of a bias to ‘old economy’ stocks that make most of their money overseas, with oil companies and miners the key drivers of returns.  

In contrast, UK mid- and small-cap indices, which house stocks that tend to generate most of their profits in the UK, fared badly last year. The FTSE 250 was down 19.7%, while the FTSE Small Cap index gave up 16.4%.

The same pattern plays out in terms of fund performance. Data from FE Fundinfo shows that the UK Smaller Companies sector lost 25.2% in 2022. This compares to a loss of 9.1% for UK All Companies, and a small decline of 1.7% for UK Equity Income.

Paul Marriage, who manages TM Tellworth UK Smaller Companies, points out that part of the territory of investing in smaller companies is that there will be periods of short-term pain. Due to this, it is important that investors are committed to investing for the long term.

Marriage said: “When markets are scared about things like a war in Europe or macroeconomic issues, UK small-cap is the sort of asset you run away from, really. It's not something you buy on first missile, unfortunately, and it's not something you really buy when you're worried about the domestic economy.”

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Similar sentiment is echoed by Neil Hermon, fund manager of Henderson Smaller Companies (LSE:HSL) investment trust. Hermon points out that mid and small-cap stocks “tend to be more sensitive to economic slings and arrows”.

He adds: “Therefore, in a market where the economy is in a more difficult place, small and mid-cap tends to underperform.

A powerful long-term investment trend is smaller shares’ outperformance of larger companies. There is plenty of logic behind the argument. Smaller companies have higher potential for growth. As the late Jim Slater said, “Elephants don’t gallop.”

Research by the London Business School found that £1 invested in 1955 in UK smaller companies would have grown to £7,933 by the end of 2020. In contrast, £1 invested in UK large companies over that 65-year period would have grown to £1,054.

Hermon says that the reasons for smaller companies historically outperforming larger shares remain in place.“It’s basically about the law of large and small numbers, growing from a smaller base, more innovative industries, the ability for management team to have more of an impact, a source of new ideas and technology. All those remain valid.

“So, we don’t see a reason why small companies won’t continue to deliver great long-term returns for investors. This year [2022] has been difficult, but that doesn’t really damage the long-term ability for small companies to do that.”

Cautious funds disappoint

Rising interest rates caused bond prices to fall sharply in 2022. As a result, the “safest” multi-asset fund sector produced the biggest losses, due to having a greater proportion of its assets in bonds.

Data from FE Fundinfo shows the Mixed Investment 0-35% Shares sector lost 10.9% in 2022, whereas Flexible Investment (in which funds can hold up to 100% in shares) was down 9%.

The same trend applies to the popular passively managed Vanguard LifeStrategy fund range. Vanguard’s ready-made portfolios hold a collection of index funds and exchange-traded funds (ETFs). Each LifeStrategy fund holds a different proportion of shares, ranging from 20% to 100%, with the remainder in bonds.

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In 2022, the five funds in the range have not performed in line with their level of risk, as the 20% version has produced the biggest losses, followed by the 40%, 60%, 80% and 100% options. A larger ratio to bonds dented returns.

In addition, the sharp sell-off in bond prices in 2022 led to steep declines for two bond fund sectors considered to be the most cautious. In 2022, the average UK gilt fund lost 23.9%, while the typical UK index-linked gilt fund is down 35.3%.

The lesson for investors is that even safe bond funds can fall sharply over a short-term period when there is an unfavourable market backdrop, which has been the case for bonds because of rising interest rates.

In the case of UK index-linked bonds, the sharp falls in bond prices have ultimately outweighed their inflation benefits. Such funds offer inflation protection by paying a level of interest linked to price rises in the market where the bonds are issued.