Investors’ eyes will usually be drawn to those funds that sit at the top of their respective sector tables, however our most recent study shows that there is a high likelihood that funds that are top quartile over one year won’t be able to repeat those returns in the next.
According to FE Analytics, out of the 67 IMA UK All Companies funds that delivered top quartile returns in 2013, only 17 of them [25 per cent] sit in the top quartile in 2014.
They include JOHCM UK Dynamic, JOHCM UK Growth, Standard Life UK Equity Unconstrained, Henderson UK Equity Income & Growth and FP Matterley Undervalued Assets.
Source: FE Analytics
In the IMA UK Equity Income sector, only eight of the 22 funds that were top quartile in 2013 have managed to replicate that relative outperformance so far this year. Those funds include the likes of CF Miton Multi Cap Income, Invesco Perpetual UK Strategic Income and Royal London UK Equity Income.
The study revealed that it is a very similar situation in the UK Smaller Companies sector, as only five – out of a possible 13 – funds have been top quartile in both 2013 and 2014. All told, it means that just 30 per cent of UK equity funds that were top quartile last year have managed to achieve that feat again so far in 2014.
FE Alpha Manager David Coombs (pictured), who only invests in closed and open-ended funds across his Rathbone Multi Asset Range, says that chasing past returns is one of worst mistakes investors can make and therefore never chooses a fund on the basis that it has already performed well.
“Quartile numbers give you little to no information about a manager. All they serve to do is stir up interest in an asset class or fund, but you still have to do all your due diligence,” Coombs explained.
However, Gavin Haynes – managing director at Whitechurch Securities – says that investors do often end up buying a fund because it has topped its respective table over one or two years.
“There is definitely a trait among investors [to buy funds that have already performed well]. People are becoming increasingly fixated on short-term performance and the funds that have shot the lights out will always attract a lot of attention,” Haynes said.
“However, almost any fund which is at the very top – or bottom – of a sector over a short period of time will be there because it has a significant bias, be it a sector, style or market-cap.”
Haynes says there are a number of reasons why so many UK funds have been unable to replicate their 2013 returns in 2014.
“First of all, one of the major reasons behind is that the funds with high weighting to mid and small caps last year will have been ahead of the sector. Mid and small caps outperformed last year, but so far in 2014, FTSE 100 stocks have marginally outperformed,” Haynes said.
Performance of indices in 2013
Source: FE Analytics
“Last year was the first year since the global financial crisis when the consensus was optimistic rather than pessimistic. Investors felt more comfortable buying up undervalued cyclical stocks, but that re-rating is largely over, so to speak.”
“Now, investors are taking a more “wait and see” attitude and therefore it has been the mega-cap stocks which have led the market.”
Haynes also points out that there were certain styles and sectors which outperformed last year – such as value and cyclical stocks – but haven’t rewarded investors so far this year.
He goes on to say that when FTSE 100 stocks lead the market as they are doing now it is harder for active managers to outperform whereas they can generate more alpha, giving themselves a better chance of beat the index, when smaller companies are in favour.
However, the results are very different if you look at the amount of funds that were top quartile in both 2012 and 2013.
According to FE Analytics, 70 per cent of IMA UK All Companies funds that were top quartile in 2012 were top quartile again in 2013. In the IMA UK Equity Income sector it was 53 per cent and in the IMA UK Smaller Companies sector it was slightly lower at 38 per cent.
Haynes explains one of the major reasons for this is the majority of funds that were top quartile in 2012 would have generated most of their returns in the second half of the year when market sentiment was high and the conditions were very similar to 2013.
This means it is important to look at the prevailing market conditions rather than focus purely on calendar year figures, as shifts in market sentiment don’t follow a rigid calendar.
However, buying last year’s top-quartile funds is always a dangerous game.
According to FE Analytics, out of the 63 funds that were top quartile in 2010, only 15 of them – 23 per cent –were top quartile in 2011 while only 14 per cent of IMA UK Equity Income funds were top quartile in both 2010 and 2011.
Out of the 64 IMA UK All Companies funds that were top quartile in 2011, only 13 were top quartile again in 2012, or 20 per cent.
In the UK Equity Income sector only two funds out of 21 that were top quartile in 2011 were top quartile again in 2012, or 9.5 per cent.
Given that such a large number of UK funds have been unable to consistently outperform on a year-by-year basis, it is worth mentioning the managers which have managed to deliver top quartile returns more regularly than others.
Our data shows, for instance, that Richard Colwell and FE Alpha Manager Leigh Harrison’s five-crown rated Threadneedle UK Equity Alpha Income fund has been the most consistent top-performing fund in the equity income sector, delivering top quartile returns in 2011, 2012, 2013 and so far in 2014.
It also outperformed the sector in 2010, though it was second quartile that year.
Source: FE Analytics
In the IMA UK All Companies sector, no funds have been top quartile in 2014, 2013, 2012 and 2011. One of the most consistent outperformers, however, has been FE Alpha Manager James Henderson’s Henderson UK Equity Income & Growth fund.
It is top quartile in 2014 and was top quartile in 2013 and 2012. It outperformed the sector in 201, but was second quartile, and was top quartile again in 2010.
GVO UK Focus has performed in similar way, beating the sector 2014, 2013, 2012, 2011, 2010 and 2009. However, it fell into the second quartile in 2012 and 2011.
