A recent FE Trustnet study suggested that larger UK Equity Income funds have tended to underperform against their smaller rivals and the wider market as a whole.
Hepworth and McDaid, who head up GAM’s fund of funds division, firmly believe that the bigger the fund gets, the more difficult it becomes to outperform, which is why they are looking for funds that aren’t past the stage where they can no longer generate alpha.
The duo are also confident on UK equities. They highlight their three favourite UK managers who still have the flexibility to run their funds without taking liquidity risk.
Old Mutual UK Alpha
For their more general UK exposure, Hepworth and McDaid are using star manager Richard Buxton’s Old Mutual UK Alpha fund.
“We use Richard Buxton because of his pedigree,” Hepworth said.
“We use the fund as much more of a core holding, but he has a good track record of generating returns in excess of the benchmark and has demonstrated he can add value.”
Buxton is generally regarded as one of the best UK fund managers. He made the high-profile move from Schroders to Old Mutual in May last year.
He posted top-quartile returns in seven discrete calendar years from the time he took charge of Schroder UK Alpha Plus at its launch in 2002 to the time he left.
While still very early days, his Old Mutual UK Alpha fund has also performed well.
It has returned 17.10 per cent since its launch while the IMA UK All Companies sector and the FTSE All Share have returned 13.26 per cent and 7.65 per cent, respectively.
Performance of fund vs sector and index since May 2013
Source: FE Analytics
Buxton is extremely positive on UK equities and believes markets are entering a decade-long bull run.
He recently told FE Trustnet that there are also a number of mega cap stocks, such as Shell, Lloyds and Rio Tinto, that he thinks look very cheap.
Old Mutual UK Alpha has already grown quite substantially since Buxton took over, increasing from £150m to £1bn in size.
While Buxton says he always keeps a close eye on capacity issues, he explains that it is a genuinely scalable product as he will always invest around 80 per cent in the FTSE 100.
The fund requires a minimum investment of £1,000 and has a TER of 1.6 per cent.
GAM UK Diversified
McDaid and Hepworth have been backing one of their colleagues, FE Alpha Manager Andrew C Green, recently because they rate his £252m GAM UK Diversified fund.
“Andrew is a true value, or contrarian, investor,” Hepworth said.
“He has a fantastic long-term track record but his style can, to a degree, lead to periods where he might underperform.”
Green has managed his fund since its launch way back in August 1990.
According to FE Analytics, it is one of the best performers in the IMA UK All Companies sector over this time with returns of 1,829.28 per cent, which is close to triple the gains of its FTSE All Share benchmark.
Performance of fund vs sector and index since Aug 1990
Source: FE Analytics
Its outperformance hasn’t been very high recently, however, but GAM UK Diversified has beaten the sector and the index over rolling one-, three-, five- and 10-year periods.
Green currently has overweight positions in the consumer services, healthcare and technology sectors and is very underweight consumer goods – which is a similar strategy to that of FE Alpha Manager Mark Costar.
McDaid added: “Andrew is also willing to sit on decent cash weightings if he doesn’t see much value in the market. However, you can see by his long-term numbers, which are very, very strong, that he has the ability to add value.”
Green currently has a high cash weighting as he says there are a number of risks facing the UK market.
“Although the fund’s allocation to cash has been somewhat reduced, we are reluctant to cut it to less than 10 per cent given the uncertainties we see ahead: the Scottish vote on independence as well as the prospect of a general election in 15 to 18 months’ time,” Green said in his most recent note to investors.
The GAM UK Diversified fund has a total expense ratio (TER) of 1.67 per cent and requires a minimum investment of £6,000.
Ardevora UK Income
Instead of using the now sizable Invesco Perpetual, Artemis or JOHCM offerings, Hepworth and McDaid prefer to use the more nimble £200m Ardevora Income fund, which is managed by Jeremy Lang.
“Jeremy Lang has an almost completely different fund to Andrew,” Hepworth said.
“He has a much more balanced approach and, for instance, won’t dive down into hyped up names in the market. He basically tries to do a similar thing to Andrew, though he just has a different way of going about it.”
Lang is probably best known for his time at Liontrust.
He managed the Liontrust UK Growth fund between 1996 and 2009, over which time the fund nearly doubled the returns of the FTSE All Share.
His Ardevora UK Income fund has started strongly as well.
Our data shows that it is the third best-performing portfolio in the IMA UK All Companies sector over three years, with returns of 58.99 per cent.
Performance of fund vs sector over 3yrs
Source: FE Analytics
It is also top quartile over one year.
The portfolio yields 3.26 per cent and is made up of just 36 holdings.
Lang has had a chunky weighting to mid caps in the past, but at this point in time the bulk of the fund is invested in large and mega caps.
Lang has a different-looking portfolio to most of his sector peers because he doesn’t tend to hold the largest contributors to the UK dividend market.
Ardevora UK Income is domiciled in Ireland, requires a minimum investment of £5,000 and has an annual management charge (AMC) of 1.5 per cent.
