Terry Smith was meant to be our Warren Buffett. His Fundsmith Equity fund, launched in 2010, became the poster child for British investing: concentrated, quality-focused, and profitable. Smith invested alongside his clients, and for a decade, this star fund manager delivered exactly what investors hoped for.
When markets fell 1% in 2011, Fundsmith rose 8%. Year after year, it beat the benchmark. By 2020, Smith had amassed £28 billion and a devoted following who believed they'd found investing's holy grail.
Today? The fund hasshed £4.6 billion in outflows since 2024. It's underperformed for four consecutive years, returning circa 55% less than the index over three years. Smithblames Novo Nordisk and currency headwinds for the poor performance. But the truth is simpler: Fundsmith has reverted to the mean.
Sound familiar? It should. Neil Woodford followed the same arc from hero to villain, ending in the spectacular collapse that left thousands nursing heavy losses.
Backing a star fund manager is riskier than you think
Here's what investors are taught: do your homework, pick a star fund manager with a solid track record, and stick with them. It feels logical. Past performance looks like evidence of skill.
But what if this conventional wisdom is actually dangerous?
New research from Morningstar's Jeffrey Ptak reveals why backing star fund managers is far riskier than most investors realise. The danger isn't just that you might miss out on extra returns; it's that you could pick a significant loser. Ptak studied large actively managed equity funds over ten years to May 2025. The gap between the best and worst performers? Just 1.6% annually over the full decade.
That sounds manageable. But here's where Ptak's research reveals the hidden danger of active fund selection. Zoom into individual years and the picture changes dramatically. In a typical year, the performance gap wasn't 1.6% but over 5%. Some years, it exceeded 6%.
This means the risk of picking a poor-performing active fund is far greater than the modest long-term averages suggest. You're not just risking slightly lower returns; you could end up with a genuine underperformer that costs you thousands.
The lesson is stark: short-term performance is wildly variable. A fund might soar one year and slump the next. These swings tend to cancel out over time, pulling results back toward average. It's called mean reversion, and it's brutal for investors who chase performance.
The real cost of choosing the wrong star fund manager
The research reveals an uncomfortable truth about active fund selection that most investors don't appreciate: the downside risk is enormous. Most of us don't judge investments over ten years. We evaluate them over three to five years maximum. And that's precisely where the danger of picking the wrong star fund manager becomes acute.
If you invest £10,000 in a fund that lags the market by 5% annually for three years, you could end up with hundreds or thousands less than if you'd bought an index fund. Repeat that mistake, and the losses compound into something far more serious.
Worse still, many star fund managers don't maintain their performance long enough for mean reversion to work in your favour. According to Ptak, fewer than half of today's active funds have been around for ten years. Even disciplined investors often get forced out prematurely.
This creates a cruel irony: investors tend to pile into funds after strong performance, buying into a star fund manager at precisely the wrong time, just as the upside fades.
The Fundsmith cycle
Fundsmith perfectly illustrates this pattern. Early investors who backed Smith in 2011 or 2013 were rewarded handsomely. The narrative was compelling: a manager who understood quality companies and thought long-term.
But starting in 2021, everything changed. Four years of underperformance followed. Investors who bought after seeing years of strong returns found themselves walking into a trap. The very strength of past performance was part of the problem.
Smith's explanations (missed tech opportunities, stock-specific issues, currency movements) may all be valid. But they miss the bigger picture. After a decade of success, Fundsmith appears to be following the same cycle that's caught out so many before: outperformance followed by disappointment as results revert toward average.
The cost of getting it wrong
That modest 1.6% annual gap between the best and worst funds over ten years masks what really happens underneath, and why choosing a star fund manager is such a high-stakes gamble. Most investors don't experience that smooth average; they experience the volatile years that make it up.
Ptak's research shows the true risk: pick wrong during those critical three-to-five-year periods when you're actually paying attention, andthe damage can be severe. You're not just missing out on gains; you could be looking at substantial losses compared to a simple index fund. Not just financially, but emotionally. Bad experiences create lasting scars that affect future decision-making.
The cruel mathematics of compounding work against you too. Early losses require disproportionately large gains to recover. A 20% loss needs a 25% gain to break even. A 50% loss needs a 100% gain.
A simpler path
If picking a star fund manager is so risky, why take the gamble at all?
That's the question driving the steady growth of index investing. Index funds don't try to beat the market (they aim to match it by holding all or most companies in a benchmark like the FTSE 100 or MSCI World.
The advantages are clear: low costs, transparency, and consistency. You won't beat the market, but you won't underperform either. For most investors, that's a trade-off worth making.
Ptak's research supports thisevidence-based approach. If even the best active funds deliver only a small edge over the long term, and only if you pick the right one and stick with it, then avoiding the guessing game altogether makes sense.
Don't chase stars, follow evidence
It's human nature to look for patterns in performance. When we see a fund outperforming year after year, we want to believe we've found something special (a manager with unique insight or skill.
But history suggests otherwise. Past performance is a poor predictor of future results. Many funds that shine briefly go on to disappoint. The damage they cause can be far greater than investors realise.
What Ptak's analysis shows is that backing a star fund manager isn't the low-stakes decision it's often portrayed as. Over the short periods when most of us judge our investments, the gap between success and failure can be wide and costly. The research reveals that the biggest risk isn't missing out on stellar returns; it's ending up with a significant underperformer.
The best strategy for most people isn't chasing outperformance (it's avoiding underperformance. Invest in a well-diversified, broadly passive portfolio and stick with it.
Star fund managers come and go. But the market endures. Follow that, and you won't go far wrong.
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