A fund’s Alpha is the value it adds to the performance of a benchmark, with a positive annualised figure suggesting the fund consistently makes higher returns than its index.
Our figures show that the average annualised Alpha of top-quartile funds is significantly higher in certain sectors, suggesting that picking the right management team could have a far greater impact on returns.
Average annualised Alpha of top-quartile funds
| Sector | Alpha (%) | Sharpe ratio |
|---|---|---|
| IMA Asia Pacific ex Japan | 7.23 | 0.66 |
| Global Emerging Markets | 6.69 | 0.55 |
| UK Smaller Companies | 6.02 | 1.23 |
| UK All Companies | 4.81 | 0.65 |
| IMA Europe | 4.41 | 0.34 |
| IMA North America | 3.9 | 0.59 |
| IMA Mixed 20%-60% Shares | 2.01 | 0.6 |
| IMA UK Equity Income | 2.01 | 0.6 |
Source: FE Analytics
Our study looked at Alpha added to a fund’s own benchmark, and suggests that picking the right funds is most important in the IMA Asia Pacific ex Japan region.
Top-quartile funds added an average of 7.23 per cent of Alpha to their benchmark over the past three years in the sector.
In the Global Emerging Markets sector, top-quartile funds added an average of 6.69 per cent, while the figure is 6.02 per cent in the IMA UK Smaller Companies sector.
The figure for the IMA UK All Companies sector is 4.81 per cent – although this may have been dragged up by the mid cap funds that the sector houses – and is 4.41 per cent for European funds.
It is understandable that the figures for the IMA UK Equity Income and IMA Mixed Investment 20-60% Shares sectors are substantially lower, given the income focus of the majority of these funds.
However, as most funds either aim to beat inflation and thereby preserve investors’ capital, or have the twin aim of achieving capital growth while providing a yield, capital returns are still relevant.
The figure for the IMA North America sector is hugely influenced by a single outlier. The tiny, institutional CF Greenwich portfolio sits in the sector despite tracking a small cap index.
Once its annualised figure of 21.3 per cent is removed, the figure for the sector drops from 3.9 to 3.11 per cent.
Although the top funds in the two emerging markets sectors have added more value to their benchmark, the managers in the UK Smaller Companies sector have made their returns by taking on less risk.
The Sharpe ratio measures how much extra returns have been generated from each notional unit of risk, with a higher figure showing the manager has produced more returns per unit of risk taken on.
The figure of 1.23 for the top-quartile funds in the IMA UK Smaller Companies sector is almost double the second-best – the 0.66 recorded by the IMA Asia Pacific ex Japan sector.
This suggests that the higher Alpha in the IMA Asia Pacific ex Japan sector comes at the expense of higher risk.
Our data indicates that paying for top management generally pays off. For example, even those sectors that score a relatively low amount add a significant amount of value to the benchmark.
AWD Chase de Vere’s Patrick Connolly (pictured) said: "If you are looking at mainstream sectors such as the UK Equity Income or North America ones, a lot of stocks are held in common."
"However, in sectors such as emerging markets or smaller companies, there are more opportunities to pick stocks people don’t know so well.""This means the funds in these sectors that do outperform tend to do so more regularly, either because the managers have better stockpicking skills or more research capabilities."
"It’s much harder to outperform in markets that are well-known and understood by everybody."