One of the basic tenets of investment is not to buy something an asset just because its price has gone up. And yet in the last decade, performance chasing has been a much better strategy than buying investments which have seen their prices fall sharply, a blind bargain-hunting approach which appeals to many people but comes with its own health warnings.

AJ Bell has put five common investing strategies to the test to see how they stacked up against each other (see table below). Perhaps not surprisingly in such momentum-driven markets, performance chasing came out top, with bargain-hunting bringing up the rear.

MODELLING THE STRATEGIES

We modelled these strategies using fund sectors, and the analysis is meant to be instructive rather than exhaustive. For performance chasers, we assumed that at the beginning of each year, they bought a fund in the best performing sector of the previous 12 months. Our bargain hunters bought a fund from the worst performing sector of the previous 12 months.

Herd investors bought a fund from the most popular sector, and contrarian investors bought a fund from the least popular sector. Our egg spreaders diversified across five equity fund sectors, putting 20% in each of US, UK, Europe, Japan and Emerging Markets funds, and rebalancing each year to achieve an equal weight in each.

Performance chasing returned 23.5% in 2024 and 154.7% over ten years. In other words, £10,000 invested in this strategy a decade ago would now be worth £25,468. Throughout 2024, this meant being invested in the Technology and Telecoms sector, which was the best performing sector in 2023, returning 38.9% in that year. Despite its success over the last 10 years, performance chasing comes with large risk warnings attached. An area which has performed well in one year has probably become a crowded trade and vulnerable to both overvaluation and profit-taking.

A HIGH-OCTANE RIDE

Performance chasing can also lead you down some less well travelled paths, often to high octane specialist sectors. In the last decade performance chasers would have invested in

technology, healthcare, India, China and commodities funds. This is reflected in the wide range of calendar year return outcomes, ranging from a loss of 14.2% to a gain of 44.4%. The same risk applies equally to our bargain-hunting strategy, as the extremes of performance, both positive and negative, tend to occur in the most specialist funds, often exhibiting low levels of diversification across industry or geography.

Recent market trends have tended to be extreme in both size and duration, most notably in the technology sector, which goes a long way to explaining why performance chasing has proved so successful. But even so, simply buying and holding a global tracker fund has delivered substantially more than a performance chasing approach over the last decade. It has also done so at a lower cost, and with less effort than switching your investments every 12 months. £10,000 invested in a global tracker fund 10 years ago would now be worth £32,510.

The thing is though, that a global tracker fund implicitly follows a performance chasing strategy. Stocks which have done well become a bigger part of the index, and hence of the funds which follow it. Some of the biggest returns in the global stock market have in recent years been driven by a small clutch of big US technology companies.

The result is the so called ‘Magnificent Seven’ US tech titans now make up 22% of a global tracker fund. That’s before you add up the other technology stocks from the US stock market, or indeed the wider world, which are exposed to the same industry theme. A reversal in fortunes in this sector could therefore prove painful for fans of index funds.

A BIT MORE DIVERSIFICATION

Against this backdrop there’s a case to be made for a strategy which does a bit more egg spreading. There’s no need to keep to 20% in each region as per our analysis. Investors can dial up or down exposure to depending on their confidence in each market, and how much active risk they want to take versus a global tracker fund, where around three quarters would currently be invested in US shares.

If the US continues to outperform other markets, egg spreading will fall behind a simple global passive strategy. But if the current hegemony of the Magnificent Seven proves to be a speculative bubble which bursts, a little egg spreading could lessen the pain.

This isn’t an easy decision, especially if you think about it in the context of which approach will deliver the best performance. That is a known unknown. Perhaps then, it’s better to think in terms of which is the riskier approach. Underweighting the US comes with the risk of underperforming a global index tracker if the S&P 500 keeps knocking it out of the park.

On the other hand, a market neutral weighting in the US now exposes passive investors to a substantial downside if the tide turns on US tech stocks.

Ultimately you can’t choose the returns you get from investing in the stock market, but you can choose the risks you take on. Whichever approach you eventually land on, acknowledging and understanding these risks means you won’t be surprised if they materialise, and will still have the confidence to maintain your investment strategy for the long term.

DISCLAIMER: AJ Bell, referenced in this article, owns Shares magazine. The author (Laith Khalaf) and editor (Tom Sieber) own shares in AJ Bell.

‹ Previous2025-03-13Next ›