The issue of fund size has become an increasingly important topic of late, with some of the best-performing portfolios attracted huge amounts of investor capital due good past performance.
A recent FE Trustnet study suggested that the bigger a fund gets, the more it impacts performance, with the smallest UK equity income having vastly outperformed their larger rivals over the last five years.
Metcalfe, who is investment director at the white-label investment review company, is a firm believer that size will ultimately hinder the performance of a fund and has no qualms with removing a top performing and highly popular fund from his recommendation list if he feels it has become too big.
“The problem is, we can’t find any fund that appears to have done better when it has become bigger,” Metcalfe said. “For us, there is a risk in buying larger funds that you just don’t get from a smaller fund.”
One that he has recently removed has been the five crown rated Schroder UK Opportunities fund, which is headed up by FE Alpha Manager Julie Dean.
The fund had been £68m this time three years ago and while Metcalfe rates Dean as manager, he says that at £2.8bn, it is now too big.
According to FE Analytics, Dean’s fund has been a top quartile performer in the highly competitive IMA UK All Companies sector over 10 years with returns of 237.83 per cent, beating the FTSE All Share by more than 100 percentage points in the process.
Performance of fund vs sector and index over 10yrs
Source: FE Analytics
It has also been top quartile over three and five years, having delivered top quartile returns in 2009, 2011, 2012 and 2013 and second quartile returns in 2010.
Schroder’s took the decision to stem inflows into the fund in May last year and Metcalfe sold his holding a few months later in November. Since that time, Deans’ fund has been the fifth worst performing portfolio in the sector, and has underperformed against its benchmark, with losses of 2.55 per cent.
Rob Morgan, pensions and investment analyst at Charles Stanley Direct, told FE Trustnet last year that Dean’s business cycle approach means that her fund would be one of the most effected by large inflows, because the strategy leads her to have an above average portfolio turnover rate.
Metcalfe admits that it is a very short period of time to judge a fund’s performance, but he reiterates that he is happy not holding the fund as he expects it to not perform as well as it has done in the past at its current size.
“The recent underperformance is not specifically down to fund flows. However, Dean did use to buy more small-caps than she does now it is bigger. Again, its size is a risk that just wasn’t there before,” Metcalfe said.
Metcalfe has also removed FE Alpha Manager John McClure’s five crown rated Unicorn UK Income fund from his recommendation list.
With its mid and small cap bias, it has been a stellar performer since its launch in May 2004.
According to FE Analytics, it has been the best performing portfolio in the IMA UK Equity Income sector since inception with returns of 261.97 per cent and has beaten its benchmark – the FTSE All Share – by more than 130 percentage points.
Performance of fund vs sector and index since May 2004
Source: FE Analytics
It is a fund that has taken full advantage of the rally in equities since the period after the financial crash. Our data shows that while it lost money in the falling market of 2011, it was the best performing fund in the sector in 2009, 2010 and 2012 and the fourth best performer in 2013.
Like the Schroder fund, however, its AUM has spiked. It has grown from just £20m three years ago to £630m today.
Metcalfe says that while the fund has continued to do well – given its top quartile returns so far in 2014 – he says that its size now means that McClure may well be unable to replicate his past, very strong, performance.
“I was quite pleased with the reaction of our clients. They understood when I showed them the graph of the John McClure’s increasing AUM. I thought they would think I was insane getting rid of such a top performing fund, but they could recognise the fund flow.”
Metcalfe added: “I’m not saying he won’t be able to do it again, but like with Julie’s fund, there is a risk there that wasn’t there before.
McClure recently defended his fund’s size and says that if inflows were to affect the way in which he manages the portfolio, he would close it. However, he admitted that he couldn’t keep buying companies like Dillistone – which has market cap of £15m – because of liquidity constraints.
Nevertheless, he said that size wasn’t an issue at this point in time as he could still implement his strategy.
To replace his exposure to Schroder UK Opportunities and Unicorn UK Income, Metcalfe has added Ecclesiastical UK Equity Growth and Franklin UK Managers’ Focus.
The five crown rated Ecclesiastical fund is headed up by FE Alpha Manager Andrew Jackson, and its AUM is just 168m.
“It is still a very small, genuine all-cap fund,” Metcalfe explained. “The manager is very active and that is the sort of fund which we want.”
Ecclesiastical UK Equity Growth has been a top quartile performer in the IMA UK All Companies sector, and has beaten the FTSE All Share, over one, three, five, seven and 10 year periods, though the majority of those returns have come over more recent years.
Source: FE Analytics
Jackson holds 41.26 per cent in the FTSE 100, 33.1 per cent in the FTSE 250 and 22.01 per cent in the FTSE Small Cap index.
Its clean share class has an ongoing charges figure (OCF) of 0.84 per cent.
Franklin UK Managers’ Focus has an AUM of just £30m. The portfolio is equally distributed between Colin Morton, Richard Bullas, FE Alpha Manager Paul Spencer and FE Alpha Manager Ben Russon, with FE Alpha Manager Mark Hall deputising.
Like the Ecclesiastical fund, it is also a multi-cap fund and more than a third of the portfolio invested in companies with a market capitalisation of less than £1.5bn.
It has also performed well. According to FE Analytics, it has been a top quartile performer – and nearly doubled the return of the FTSE All Share – since its launch in September 2006 with returns of 97 per cent.
It has been top quartile over one, three, five and seven years, as well.
The Franklin UK Managers’ Focus fund has an OCF of 0.95 per cent.
