Past performance is quite rightly drummed into investors and advisers as not being a guide to the future, as an FE Trustnet article recently highlighted. If you buy a fund that was a top performer one year, history shows that the chances of it doing so again the next year is anyone’s guess.
However, our data suggests that a high proportion of funds in certain sectors have a proven ability of performing well in certain market conditions.
In 2008, 33 funds in the UK Equity Income fell less than their sector average, which was down 28.54 per cent over the 12 month period. Of these, 22 – exactly two-thirds – also protected better against the downside than their peers in 2011.
Only four of the funds in the sector that outperform in the depths of the financial crisis fell into the bottom quartile in 2011 – a year defined by a steep summer sell-off stemming from troubles in the eurozone. Moreover, three of these four – Schroder Income, Schroder Income Maximiser and Smith & Williamson UK Equity Income – had a change of management between 2008 and 2011.
Below is a composite portfolio of the funds that achieved first or second quartile returns in 2008, versus the UK Equity Income sector average and FTSE All Share in 2011.
The 2008 winners outperformed in 2011, driven by their strong performance when markets plummeted in the summer months. As well as outperforming, the winners also operated with significantly less volatility and a lower max drawdown figure – two characteristics they also boasted in 2008.
Performance of portfolio, sector and index in 2011
Source: FE Analytics
It’s interesting to note that the same proportion – two-thirds – of UK Equity Income funds that outperformed in the down year of 2008 also outperformed in 2007. The average UK Equity Income fund lost 1.21 per cent in 2007, while the winners of 2008 made 1.24 per cent.
Among those that were particularly strong in 2007, 2008 and 2011 were Invesco Perpetual Income and High Income, which were run by FE Alpha Manager Neil Woodford at the time, as well as Francis Brooke’s Trojan Income fund, Mark Barnett’s Invesco Perpetual UK Strategic Income fund and Leigh Harrison’s Threadneedle UK Equity Alpha Income fund.
All five were top-quartile performers over all three time periods.
Source: FE Analytics
All of the funds in question have a significant quality bias, with the vast majority of their assets in large caps. Companies with strong balance sheets, good cash flow and predictable earnings – all linked to the sustainability of dividends – are popular with all of the managers, and tend to hold up better when the market is risk-off.
Fund of funds manager Daniel Lockyer says the findings of the study illustrate the merits of studying manager styles and forecasting returns in certain market conditions.
He says it is very difficult to forecast the direction of markets in the first place, but if you have a particular view on an asset class, sector or sub-sector, he believes looking at manager track records is useful.
“I would have to agree that past performance has to be a fixture when choosing a fund, but only if you are willing to understand the circumstances of that performance,” said Lockyer, who runs the PFS Hawksmoor Vanbrugh portfolio.
“You have to make sure you are active. If your are risk-off and think defensive areas are going to do better, then it makes sense to go for a value fund run by someone like Neil Woodford.”
Charles Younes, analyst at FE Research, agrees that looking at the styles of managers and funds can help you to predict how they perform in certain market positions.
However, he points out that all rising and falling markets are different, meaning that sometimes even managers with a quality bias can be caught out when markets fall.
“In 2008 you may have outperformed because you didn’t have banks, but this wouldn’t have been enough to save you in 2011,” he said.
“Similarly, you could have outperformed during the dot com bubble because you were tech heavy, but in a rising market like 2009 this isn’t wholly relevant.”
The trend of consistent outperformance during down markets is also evident across other IMA equity-focused sectors, and even stronger in some cases.
FE data shows that 26 of the 32 Asia Pacific ex Japan funds that outperformed in 2008 – or 81 per cent – also did so in the down year of 2011. Defensive-focused funds like First State Asia Pacific Leaders and Newton Asian Income were among those that excelled in both years.
Performance of funds, portfolio and sector in 2011
Source: FE Analytics
Seventy per cent [80 out of 115] of the UK All Companies funds that were first or second quartile in 2008 also outperformed in 2011.
While there aren’t a huge number of Global Equity Income funds with a track record going back to 2008, four of the five that beat their sector in that year repeated the trick in 2011. These include quality-focused portfolios such as Veritas Global Equity Income and Newton Global Higher Income.
There was little to no correlation between top performers in times of stress across the fixed interest and multi-asset sectors, however, where there is less of a bias towards particular companies and asset classes. There was also little trend evident in IMA North America – a sector that managers have found it traditionally very hard to add value in.
The strong performance of these defensive funds in tough times also seems to have a direct correlation with underperformance during fast rising markets.
Of the 33 UK Equity Income funds that outperformed in 2008, only 9 – 27 per cent – outperformed during the 2009 rebound. Similarly, only 39 per cent of Asia Pacific ex Japan funds managed first or second quartile returns in 2009, and 35per cent in IMA UK All Companies.
As Lockyer suggests, the relationship isn’t as clear when looking at funds outperforming in fast rising markets year after year.
However, he would expect cyclically-focused managers such as Ed Leggett, who runs Standard Life UK Equity Unconstrained, and those with a small-to-mid cap bias like Alex Wright, who runs Fidelity Special Situations, to perform better when markets are on the up.
“If you are able to change your focus from funds that do better on the downside and then those that do better when it turns around, then you will do very well,” said Lockyer.
“Changing your dynamics is very hard to do, though.”
He highlights his decision to buy into Neil Woodford at the beginning of 2011, when he believed markets were set for a difficult time, as an example of him getting his timing right.
Among the fund of funds managers who have been effective at changing the dynamics of their portfolios in recent years include FE Alpha Manager Marcus Brookes, who runs the Schroder MM Diversity portfolio.
Brookes and co-manager Robin McDonald switched out of Woodford and into Sanjeev Shah, who was at the time running the Fidelity Special Situations fund, in early 2012, just in time for the equity upswing that followed.
They also cut their bond exposure in favour of cash in 2013, which helped the fund to protect against the taper tantrum in May and June.