Our data shows that 19 out of the 23 tracker funds in the IMA UK All Companies sector have produced bottom-quartile returns over the past 12 months, with the remaining four being among the very poorest-performers in the third quartile.
Analysis suggests that the relatively poor performance of large caps over the past six months may be to blame.
The FTSE All Share has risen 17.15 per cent over the past year, while the best-performing passive fund, the M&G Index Tracker, has returned 17.8 per cent.
Although it is ahead of the index, the fund is the 185th-placed portfolio out of 271 in the sector, as the majority of funds have managed to outperform the FTSE All Share.
Only four other passive funds have done so, however, and the average tracker has made just 15.62 per cent.
The average fund in the sector has made 22.82 per cent, including the effect of the passive funds weighing it down.
Performance of sector vs index and average passive over 1yr
Source: FE Analytics
Data suggests this could be the effect of the relative underperformance of the large cap stocks that make up the largest part of the FTSE All Share.
The FTSE 100 has lagged behind the FTSE 250 and FTSE Small Cap indices this year in an acceleration of a trend that began in 2012.
Relative performance of indices over 3yrs
Source: FE Analytics
It is also the case that the worst-performing passives are all those that track the FTSE 100.
Our data shows that the FTSE 100 has made 14.87 per cent over one year, less than all but 28 of the 271 funds in the sector. The 10 trackers that follow it have underperformed it.
Source: FE Analytics
Tim Gregory, head of global equities at Psigma, says it is not just a case of the FTSE 100 underperforming – the FTSE 100 and All Share indices are being pulled down by the very biggest stocks on the market.
"The large cap parts of the market have been holding back the performance of the FTSE, which is actually down since May," he said. "One of the reasons for that is the poor performance of the very large companies."
Performance of indices since 22 May 2013
Source: FE Analytics
"Companies that make up the top end of the FTSE have been struggling and of course a passive fund owns full weight in them, and the top-20 companies could be up to half the market," he said.
"In the same period the FTSE 100 was down, small and mid caps were up almost 10 per cent, so passive All Share funds which own very few mid caps but own full weight in large caps have probably done worse," he said.
One reason why the mega caps have been doing so badly is the strength of sterling, which means that money earned abroad by UK-listed countries is worth less when translated into the domestic currency.
The largest companies on the UK market mainly derive their earnings from abroad, whereas the mid and small cap areas of the market are more domestically focused.
"If you look at what makes up the FTSE – Glaxo and AstraZeneca derive almost all of their earnings internationally, Rio Tinto and BHP Billiton derive their earnings internationally, the brewer SAB Miller derives most earnings internationally, Vodafone has an important UK business but also derives a large part of its earnings internationally, and then you have the banks HSBC and Standard Chartered," Gregory said.
This has been exacerbated by sector-specific issues in the mining industry, which have caused this area to suffer in recent years – BHP Billiton and Rio Tinto are both among the 20 largest stocks in the UK market and have lost money over two years.
Passive funds were also hit hard by the market downturn over the summer, as FE Trustnet pointed out at the time, and exposure to the mining sector and to earnings in Asia in particular contributed to that.
Although the larger part of the market has been lagging in the recent past, Gregory thinks that it is now looking attractive on valuation grounds.
"We think to a degree those parts of the market [the mid caps and small caps] are now fully priced," he said. "What’s left is the most attractive part of the market, the large cap area."
Psigma is increasing its weighting to large caps on valuation grounds and reducing relative exposure to the smaller end of the market.
This raises the possibility that now could be a good time to get into passives. Gregory thinks that investors need to be very selective with their stocks, however.
He says that the UK market in particular looks fully valued and only stocks that deliver strong earnings growth from now on have space to grow further.
In a forthcoming article, FE Trustnet will highlight some large cap stocks that Psigma rates as particularly good value on a three- to five-year view.
