Oliver (pictured) says that the outperformance of many funds in recent years – especially in 2012 and 2013 – has had more to do with their weighting to small and mid-caps than the manager’s stock-picking skills. He believes that returns from UK equities will be considerably lower than they have been over the past five years because valuations are starting from a much higher base.
Investors should therefore be looking for managers who have been able to add significant value without simply increasing their weighting to the lower end of the market, he says For that reason, he has upped his exposure to Richard Buxton’s Old Mutual UK Alpha fund and Simon Brazier’s Threadneedle UK fund.
“We’ve had the likes of Richard Buxton at Old Mutual and Simon Brazier at Threadneedle and what we particularly like about them is that they have had good performance with a very high FTSE 100 weighting,” he said.
“They have had 75 to 80 per cent in the FTSE 100 and they haven’t relied on that mid and small-cap tailwind; it’s just been good, solid stock-picking.”
UK equities have performed strongly since the market bottomed after the financial crash in March 2009, with perceived higher risk areas of the market – such as mid and small-caps – leading the way.
Performance of sector vs index since Mar 2009
Source: FE Analytics
The disparity in performance between these and large caps has helped the average active UK equity fund to outperform the FTSE All Share in recent years.
Oliver, investment director at Canaccord Genuity, says this has created a real problem for investors as the last five years’ returns are unlikely to be repeated.
“We have found, over the past year, that finding a UK fund which has performed well relative to its competitors, and which hasn’t just been massively overweight mid and small-caps, has been quite challenging,” Oliver explained.
“There has been a very close correlation between how well a manager has done and how much they have had in mid and small caps. The vast outperformance of mid and small-caps has totally distorted the sector.”
“However, that’s coming home to roost now, following the sell-off we have seen this year.”
According to FE Analytics, since the market troughed after the crash in March 2009, the average fund in the IMA UK All Companies sector has returned 146.58 per cent while the FTSE All Share has returned 145.58 per cent.
The bulk of the outperformance has come in the past two years or so.
The sector beat the index in the rising markets of 2009, 2010, 2012 and 2013, but underperformed in the falling market of 2011.
Buxton is one of the highest profile managers in the business. He currently runs the £1.3bn Old Mutual UK Alpha fund, but is best known for his successful stint as manager of the Schroder UK Alpha Plus fund between June 2002 and May 2013.
According to FE Analytics, over that time the fund was a top decile performer in the highly competitive IMA UK All Companies sector with returns of 242.66 per cent, beating the FTSE All Share by more than 110 percentage points.
Performance of fund vs sector and index between June 2002 and May 2013
Source: FE Analytics
Those returns were consistent, with the fund only underperforming against the sector and index in 2004, 2008 and 2011.
Our data shows that the fund delivered top quartile returns, and beat the All Share, in the rising markets of 2009, 2010 and 2012; particularly impressive considering Buxton (pictured) has always held at least 80 per cent of his fund in FTSE 100 companies, and the smallest stocks he invests in, by market-cap, are £800m. Schroder UK Alpha Plus, under his stewardship, was a top decile performer for both its alpha generation relative to its benchmark and its information ratio. The latter measures the efficiency of a manager’s outperformance by comparing their excess return, relative to their benchmark, against the volatility of those returns.
He took over the Old Mutual UK Alpha fund last year and he manages it in the same way.
So far, while it has underperformed against the sector, its returns of 110.5 per cent are greater than those of the FTSE All Share. The fund is very concentrated as it is made up of just 36 holdings.
Though Brazier has a shorter track record, he has also managed to outperform both the sector and index.
According to FE Analytics, his £1.9bn Threadneedle UK fund has returned 62.75 per cent since he took over the portfolio in May 2010. The sector and the FTSE All Share have returned 51.21 per cent and 46.89 per cent, respectively.
Performance of fund vs sector and index since May 2010
Source: FE Analytics
Threadneedle UK outperformed the sector in 2010, 2011 and 2012 but underperformed in last year’s bull market.
Like Buxton, Brazier’s fund has a better information ratio and has generated more alpha than the average portfolio in the IMA UK All Companies sector since he took over.
The fund’s top-10 holdings include FTSE blue-chips such as AstraZeneca, BP, Unilever, Royal Dutch Shell, BP, GlaxoSmithKline and Imperial Tobacco. It is more diversified than the Old Mutual fund, however, with 80 stocks overall.