Investment professionals in the City have a tough job, made even more stressful by the bi-annual release of the “Spot the Dog” report by Bestinvest. This report, in circulation since 1994, is known as the guide that fund managers dread, as it exposes underperforming funds in a straightforward and impactful way. For managers who find their funds labeled as dogs, it can be a blow to their reputations.

The criteria for being classified as a dog in the report is simple but stringent. A fund must fail to beat its benchmark for three consecutive 12-month periods and underperform the benchmark by 5% or more over the entire three-year period. With 137 funds labeled as dogs in the latest report covering the three years up to June 30th, managers have attributed poor performance to various challenges such as US megacap concentration, sustainability-themed funds struggling with the rise in fossil fuel profits, a tough UK market, and the difficult decisions emerging market managers had to make regarding China and India.

While some managers may feel unfairly judged, others acknowledge the report’s role in holding them accountable and prompting investors to review their portfolios. Bestinvest emphasizes that funds aren’t penalized for simply making stylistic bets that don’t pay off, as different strategies go in and out of favor over time. The purpose of the report is to encourage investors to assess their fund choices and decide if they still have confidence in them.

One interesting question raised is whether the list of dog funds could serve as a contrarian indicator for future outperformance. By analyzing the performance of the top 10 dog funds in each report over slightly longer periods, it becomes clear that these funds have struggled to catch up to their benchmarks despite some improvement in returns. Unlike individual stocks that can undergo restructuring or other changes to improve performance, mutual funds have limited options for self-improvement.

In conclusion, funds identified as dogs in the Spot the Dog report may face an uphill battle to regain their footing and outperform their benchmarks. While the report serves as a wake-up call for underperforming funds, the path to recovery may be challenging due to the nature of mutual funds compared to individual stocks. As a contrarian indicator, the effectiveness of the report is debatable, as fund managers need to step up their game quickly to avoid being labeled as dogs in the future.