Volatility measures the dispersal of returns without taking into account their direction, with a sudden move upwards in value having the same effect on the overall figure as a sudden loss of value.
This isn’t what investors intuitively think of as risk, however, which is centred more around the risk and degree of loss.
For retail investors, and for advisers serving them, downside risk is possibly the more relevant measure.
Downside risk measures the dispersal of only the returns beneath a certain “risk-free” rate, which FE Analytics defines as a generous 3.5 per cent return from cash as default.
A fund with a lower downside risk losses less money, on average, when it falls.
The sortino ratio is calculated like the sharpe ratio, except it uses the downside risk rather than the volatility.
Maximum drawdown is a useful figure, but that only tells you about one specific time: the loss you would have made if you had bought and sold at the worst possible times.
Downside risk and sortino give you an idea of how the fund performs when it does badly, which typically means how it protects investors from falls in the market.
Funds with the lowest volatility don’t always have the lowest downside risk, suggesting that investors might be able to improve their risk-return ratio by taking this measure into consideration.
Downside risk and volatility over 3yrs: IMA UK All Companies
| Fund | Downside Risk | Rank | Volatility | Rank |
|---|---|---|---|---|
| JOHCM - UK Opportunities | 12.23 | 1 | 11.52 | 1 |
| Liontrust - Special Situations | 12.74 | 2 | 11.99 | 2 |
| Cazenove - Multi Manager UK Growth | 13.31 | 3 | 12.68 | 5 |
| SJP - UK & General Progressive | 13.6 | 4 | 13.05 | 8 |
| Ignis Intl - Cartesian Enhanced Alpha | 13.63 | 5 | 13.55 | 19 |
| EFA - New Horizon Income & Growth | 13.65 | 6 | 12.74 | 6 |
| Ecclesiastical - Amity UK | 13.67 | 7 | 12.31 | 3 |
| Unicorn - Outstanding British Companies | 13.68 | 8 | 13.74 | 22 |
| Lindsell Train - CF Lindsell Train UK Equity | 13.88 | 9 | 13.37 | 16 |
| R&M - UK Equity Unconstrained TR | 14.09 | 10 | 13.26 | 14 |
Source: FE Analytics
Some of the funds in the top-10 in the IMA UK All Companies sector for downside risk and volatility over three years are the same, but there are also some surprising anomalies.
Unicorn Outstanding British Companies is only 22nd out of 268 funds in terms of volatility, but the 8th most successful in terms of downside risk.
The five crown-rated fund is managed by FE Alpha Managers Chris Hutchinson and John McClure, and has a strong record in recent years.
Over five years it has made 94.58 per cent as the FTSE All Share has made 32.73 per cent, according to data from FE Analytics.
Performance of fund versus sector and benchmark over 5yrs
Source: FE Analytics
The fund has only 23 positions, but it looks to pick leading British companies with a technological edge, many of which the managers have held in their VCT and small-cap funds.
FE Alpha Manager Nick Train’s £672m CF Lindsell Train UK Equity portfolio is another fund to have a better ranking in terms of downside protection than of volatility.
His fund has the 16th lowest volatility and the 9th lowest downside risk. It focuses on blue-chips with global earnings streams, which should be in theory less volatile.
It is another fund that is highly concentrated, suggesting that good stock-pickers can produce returns with less downside risk even with a more concentrated portfolio, which is often perceived as being more risky.
Oriel's Patrick Barton highlighted the flaws of this assumption in a recent interview with FE Trustnet.
Dublin-domiciled Ignis International Cartesian Enhanced Alpha is another fund to have lower downside volatility than its overall score.
The £40m fund is run by FE Alpha Manager Jeremy Hall and is a top-quartile performer over three and five years.
It has made 54.97 per cent over the past five years, according to data from FE Analytics, while the FTSE All Share has made 32.73 per cent over that time.
Performance of fund versus sector and benchmark over 5yrs
Source: FE Analytics
There are a handful of funds that are in the top-10 in the sector for volatility, but score less highly for downside risk.
Neptune UK Mid Cap has the fourth-lowest volatility in the sector, which is highly impressive for a mid-cap fund given the sector is more volatile than the whole market.
However, our analysis suggests a significant chunk of that low volatility comes from it moving up less rather than moving down less.
It is 7th in terms of volatility and just 17th in terms of downside risk.
Unicorn Free Spirit is 4th in terms of volatility and 11th in terms of downside risk, while Liontrust UK Growth is 9th in terms of volatility and 20th in terms of downside risk.
The sortino ratio relates the returns made over the period to the unit of downside risk taken.
Data from FE Analytics shows that among the top-10 funds there is little difference with the ranking in terms of sharpe ratio, with the exception of the Ignis Cartesian Enhanced Alpha fund.
Sortino and Sharpe over 3yrs: IMA UK All Companies
| Name | Sharpe | Rank | Sortino | Rank |
|---|---|---|---|---|
| Liontrust - Special Situations | 2.02 | 1 | 1.83 | 1 |
| Neptune - UK Mid Cap | 1.99 | 2 | 1.73 | 2 |
| Lindsell Train - CF Lindsell Train UK Equity | 1.71 | 3 | 1.67 | 3 |
| Unicorn - Outstanding British Companies | 1.6 | 4 | 1.59 | 4 |
| Barclays - UK Lower Cap | 1.55 | 5 | 1.52 | 5 |
| Cazenove - UK Opportunities | 1.53 | 7 | 1.44 | 6 |
| Invesco Perp - UK Growth | 1.44 | 10 | 1.39 | 7 |
| Unicorn - Free Spirit | 1.55 | 5 | 1.36 | 8 |
| Ignis Intl - Cartesian Enhanced Alpha | 1.32 | 21 | 1.35 | 9 |
| Cavendish - Opportunities | 1.53 | 9 | 1.32 | 10 |
Source: FE Analytics
Further down the table there are some anomalies, however.
R&M UK Equity Unconstrained is 19th in terms of sortino but only 23rd in terms of sharpe.
Invesco Perpetual UK Aggressive is 27th in terms of sharpe but just 21st in terms of sortino, while Jupiter Growth & Income is 36th in terms of sharpe but 27th in terms of sortino.
In a series of articles over the coming weeks FE Trustnet will focus on funds in different sectors and highlight those that have been particularly good at limiting losses.