Investors have invested over £53 billion in funds that have consistently underperformed, with managers having little or no exposure to AI stocks and the energy sector underperforming.

Global equity funds were the biggest offenders in Bestinvest’s latest Spot the Dog report. 44 funds made the list, a slight improvement from 51 funds at the start of the year. A third of these global funds focus on sustainable investing and missed out on the gains from the rally in oil and gas stocks.

UK equity funds were also prominently featured, with 44 funds flagged, a significant increase from 12 a year ago. Ethical and sustainable funds make up around a quarter of these underperformers, largely due to their lack of exposure to the UK energy and commodity sectors.

The report found that 137 equity funds with £53.42 billion in assets consistently underperformed. The full list can be found here.

The number of dog funds has fallen by 9 percent since the beginning of the year, when 151 funds were on the list. However, it is still significantly higher than the 56 funds that were on the list a year ago.

The value of assets tied up in these underperforming funds has also fallen sharply, falling to £53.42 billion, 44 percent less than the £95.26 billion reported in the previous edition, mainly because some large funds narrowly avoided the list.

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To be included in the list, a fund must underperform the market in which it invests by 5% or more over a three-year period.

A second filter is that the fund must also have underperformed in three consecutive 12-month periods.

Fund performance can decline for a variety of reasons, ranging from poor decision-making to investment strategies that are no longer popular given current market trends. This issue is particularly pressing as investors question why so many funds continue to underperform their benchmarks, especially given the recent boom in AI that has given new momentum to the U.S. and global equity markets.

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However, the rally has been driven by a small group of mega-cap US companies that benefit from artificial intelligence, making it challenging for fund managers who do not have exposure to these few giants to keep up.

The AI-driven rise in select stocks does not reflect the broader stock market’s woes over the past three years. One notable trend consistent with previous reports is the high representation of ESG and ethical funds among the underperformers. These funds make up a fifth of Spot the Dog’s list and reflect the unexpected rise in oil and gas prices due to supply chain issues following the pandemic and Russia’s invasion of Ukraine in 2022.

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Jason Hollands, managing director of Bestinvest, said: “The high number of sustainable or responsible funds in the latest Spot the Dog report partly reflects the strong performance of oil and gas stocks in 2021-22. Over the three-year period covered, the MSCI World Energy Index delivered a total return of 98% in GBP terms, compared to 28% for the MSCI World Index. The alternative and renewable energy market, in contrast, struggled, with the MSCI Global Alternative Energy Index falling 38% over the same period.”

Hollands expects the number of ESG funds to decline in future reports as the impact of rising energy stocks fades. He also pointed to the dominance of companies like NVIDIA (NVDA), Alphabet (GOOGL), Amazon (AMZN), Meta Platforms (META) and Microsoft (MSFT) – the so-called “Magnificent Seven” – that have driven market performance recently. The Bloomberg Magnificent Seven Index is up 42% over the past year, and these companies now make up a significant portion of the S&P 500 (^GSPC) and MSCI World indices.

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The last edition of the report included two of the UK’s best-known funds – Terry Smith’s Fundsmith Equity and Nick Train’s WS Lindsell Train UK Equity – but both have now disappeared from the list. Nevertheless, the presence of large funds remains a cause for concern: ten funds over £1 billion in size account for £26.81 billion, half of the assets of the poorly performing funds.

Hollands said: “The Spot the Dog report is a timely reminder for investors to regularly review their portfolios. While the report highlights poorly performing funds, it also stresses the importance of monitoring investments and considering whether changes are needed.

“It is critical for investors to understand whether a fund’s difficulties are due to short-term problems or deeper issues in deciding whether to keep or sell the fund.”

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