Our data shows that only 43 out of the 272 funds in the IMA UK All Companies sector have beaten the FTSE All Share this year, in a reversal of the trend of last year.
The sharp correction in the FTSE 250 and the relative outperformance of the FTSE 100 are to blame, highlighting how many active managers did so well for so long off the back of overweighting mid-caps.
Rob Morgan , investment analyst at Charles Stanlet Direct, said: “You always get periods where the index does well and gets a bounce like this.”
“One period was the late 1990s when you had stocks like Vodafone dominating the index and index tracking was the superior strategy for two to three years.” “However I think the current period we are seeing is probably shorter term phenomenon on the basis that we have had a stellar period for small and mid caps and we have had a bit of profit-taking as valuations became quite stretched, therefore its natural to have this sort of rotation.”
“During this sort of period it’s very hard for active managers to beat the index. The best performers have been large utilities and energy stocks etc and managers tend to be underweight these areas even if they have a full weighting in the large caps.”
Data from FE Analytics shows that the FTSE All Share has made 2.19 per cent this year as the average IMA UK All Companies fund has made just 0.22 per cent.
Performance of sector versus index in 2014
Source: FE Analytics
This is in contrast to last year, when the average IMA UK All Companies fund made 26.21 per cent to the index’ 20.81 per cent.
That was the second successive year of outperformance for active funds, which are ahead of the index over one, three and five year periods.
Performance of sector versus index over 5yrs
Source: FE Analytics
We reported on this phenomenon last year, when 19 out of the 23 tracker funds in the sector were in the bottom quartile over 12 months.
Our data now shows that 14 of the passive funds are in the top quartile and the remainder second quartile in 2014.
Tom Becket, chief investment officer at Psigma said: “Part of that [reversal] will have been the long overdue bounce in the oil and mining sectors, where most UK managers have been structurally underweight, but there is also decisive evidence that the 'wondrous' outperformance of the last few years can be attributed purely to a structural overweight in the mid-cap sector.”
As Becket says, the major reason for this reversal of fortunes is the changing behaviour of the large cap end of the market, which makes up more than 80 per cent of the FTSE All Share. Ever since the market correction of summer 2011, small and mid caps have seen a period of strong outperformance against the FTSE 100 which has gone into reverse this year.
Relative performance of indices of large caps over 3yrs
Source: FE Analytics
Active managers have been able to take advantage of this by buying more small and mid caps, which passive funds are unable to do.
For example, over three years the Neptune UK Mid Cap fund is the top-performing fund over three years with returns of 81.05 per cent.
Axa Framlington UK Mid Cap is third, while the other funds at the top of the table have heavy weightings to small and mid caps.
In the year-to-date the mid cap index is now in negative territory, however, down 0.45 per cent as large caps are up 2.73 per cent.
Many managers and analysts warned that this reversal was likely to occur this year at the end of 2013.
For example, FE Alpha Manager Alex Wright told us back in December that the FTSE 100 was looking cheaper and home to the better prospects.
However, our data shows that few managers have been able to take advantage of this shift.
The top-performing active funds this year have been those of Mark Slater, who has done well thanks to good stock-picking in the small cap space.
Newton UK Opportunities is the next-best performer, followed by FF&P Core UK Equity and Invesco Perpetual High Income.
Large-cap heavy funds such as Majedie UK Focus and Franklin UK Blue Chip have outperformed, as have some mid-cap focused funds such as the Neptune portfolio.
Morgan says that he wouldn’t switch his portfolios into passives, however, as he expects the current trend to be short-lived.
“It’s probably a fairly short term phenomenon and I would expect over the longer term for small and mid caps to outperform,” he said.
James Davies, head of fund research at Close Brothers agrees.
“I think if you base your view of active versus passives on six months’ performance of the FTSE 100 then your long term investment outcomes are going to be disappointing,” he said.
“We are first and foremost a house that believes in active management, and that through in-depth research it is possible to identify active managers who are capable of delivering performance over the long term.”
“That said, we do use passive index strategies where appropriate. This can be for short term tactical allocation where we want broad market exposure for minimal cost, or in markets where we don’t have a high level of manager conviction.”
“Right now many of the active managers we are speaking to in the UK are seeing more value in the mega-caps than further down the market-cap spectrum, but I don’t buy into the argument that this automatically means you should be buying a FTSE 100 tracker.”