New York

The Worst of Times: What Dickens Can Teach Investment Writers About Conveying Bad News

Nandini Rao 18 January 2022

“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness”

So begins Charles Dickens’ novel A Tale of Two Cities, which was first serialised this month in 1859. Can investment writers afford to be as bold as Dickens when “the best of funds” has a slip-up on an icy patch and experiences the “worst of times” for a while?

This Morningstar article shows that even Gold-rated funds have experienced the odd blip or two. In such cases, it is important for investment writers to communicate what went wrong and why, without causing panic. The bad news needs to be delivered in an honest, frank and reassuring way.

“Facts alone are wanted in life. Plant nothing else, and root out everything else” (Hard Times)

Be open and transparent about the fact that the fund did underperform.  It may sometimes be tempting to gloss over underperformance by using impenetrable sentences or jargon. Some quantitative hedge funds did precisely that at the start of the subprime crisis. But as mutual funds have much heavier disclosure requirements than hedge funds, an investor will always be able to tell when a fund has underperformed, with much of the necessary information available at the click of a mouse.

Transparency also involves using appropriate yardsticks to measure returns. Compare apples to apples by talking about a fund’s return in relation to its correct benchmark or peer group. Don’t compare a large-cap fund to a mid-cap index to make the fund’s returns look better in a bear market (when large-caps usually outperform mid-caps).

Excluding information about returns or using elaborate disguises is unlikely to help build trust with your readers.

“Heaven knows we need never be ashamed of our tears…” (Great Expectations)

Always explain what caused the fund to underperform. In his letter to the Chancellor to explain why the Bank of England “underperformed” in missing its inflation target, Governor Mark Carney clearly identified the timeframe and the reasons for low inflation:

“The underlying causes of the below-target inflation of the past year and a half have been: sharp falls in commodity prices; the earlier appreciation of sterling; and, to a lesser degree, the subdued pace of domestic cost growth.”

Delve into performance attribution reports to identify what hurt the fund’s performance. Perhaps a few stock picks didn’t pay off or the fund’s peer group was hurt by a common factor. The fund manager’s insights are invaluable here (see our tips on how to interview fund managers).

Performance reports should also make it clear when the fund did badly otherwise you may risk clients judging the long-term potential of a fund by the performance of a month or a quarter.

If the word count allows, try to provide some context by referring to economic developments in the period. Did the fund do badly because of factors outside the fund manager’s control, such as “black swan” events like the collapse of Lehman Brothers, or natural disasters that nobody could have predicted?

“Meat, ma’am, meat” (Oliver Twist)

Performance attribution can help you pick out the positives as well as the negatives. Consider a hypothetical emerging-markets equity fund that had a large overweight to Mexico around the US election. This may have weighed on returns. However, any Russian exposure would have contributed to returns as Donald Trump’s victory boosted sentiment towards the country’s markets. It is worth highlighting the silver lining in the clouds.

Broaden your horizons by looking beyond the period covered in your report. Look at the fund’s returns in other timeframes. Rather than just saying “The fund underperformed its benchmark”, you could talk about times when the fund did well. For example, you could say “The fund underperformed its benchmark in December but outperformed over the fourth quarter and the full year”.

“Consider nothing impossible, then treat possibilities as probabilities” (David Copperfield)

Reassurance is important. So avoid alarming statements such as “the fund experienced a disaster in June”. The same goes for extreme comparisons, which may be unhelpful in certain contexts or to non-financially-savvy readers. For example, GMO’s letter to investors in the second quarter of 2016 used references to purgatory and hell to identify investment scenarios. While this may fly in a hedge-fund report, it probably won’t go down as well in a fund commentary targeted at retail investors.

If the scope of the report allows, try to draw in the fund manager’s longer-term strategy. A few sectors may have performed especially badly but the manager could still have high conviction in these sectors and expect them to turn around. Or, you highlight the fund manager’s future plans to improve the fund’s performance. Governor Carney outlined the Monetary Policy Committee’s plans to bring inflation back to target in his latest letter to the Chancellor.

At the same time, don’t over-promise with statements such as “The fund should generate double-digit returns if scenario X materialises or when sectors A and B recover”. Hostages to fortune are never a good idea – even if your compliance team lets them past. As Ebenezer Scrooge acknowledged, we should always be cautious when looking ahead.

“‘Ghost of the Future,’ he exclaimed, ‘I fear you more than any spectre I have seen.’” (A Christmas Carol)