The rising markets of 2012 and 2013, which saw small and mid caps outperform as well as more economically sensitive cyclicals, resulted in the same types of funds outperforming over consecutive calendar years.
However, worries over valuations, a spate of earnings downgrades and the impending threat of rising interest rates have seen markets move sideways this year, and some of the riskier areas such as mid caps have gone down.
FE Alpha Manager John Chatfeild-Roberts spoke about the rotation in more detail earlier this week.
While six months of underperformance is not necessarily a cause for concern, the extent to which some of the top performers of recent years have lagged behind their peers is very significant.
Here we look at the portfolios in the popular IMA UK Equity Income, UK All Companies, Global and Global Equity Income sectors that have followed top quartile performance in 2013 with bottom-quartile performance so far this year.
UK Equity Income
One of the standout themes in the UK Equity Income sector in recent years has been the outperformance of domestic cyclicals since the eurozone crisis in 2011 – particularly in the small and mid cap space.
Deep-value funds with an emphasis on these types of stocks such as Schroder Income and Standard Life UK Equity Income Unconstrained have thrived as a result.
However, in 2014 this trend has reversed, with more defensive large cap stocks doing much better.
This has affected funds such as the £1.5bn Schroder Income fund, whose managers Kevin Murphy and Nick Kirrage are known for their deep-value style.
A case in point is the massive decline in the share price of one of its largest holdings, Morrisons, which has fallen by more than 30 per cent this year. Other top holdings that have experienced losses include HSBC and Vodafone.
The five crown-rated fund has lost 1.18 per cent so far this year after two successive years of top quartile performance.
Performance of fund, sector and index over 3yrs
Source: FE Analytics
Other former top performers currently on the back foot include the £128m Old Mutual UK Equity Income fund, managed by Stephen Message, and the £222m Ardevora UK Income fund, which is co-managed by Jeremy Lang and William Pattisson.
Both funds have also suffered from sharp falls in the FTSE 250, sending them to the bottom quartile of the sector after a strong 2013.
However, both are still top quartile over three years and the Old Mutual Equity Income fund is top quartile over five and 10 as well.
Performance of funds, sector and index over 3yrs
Source: FE Analytics
Other funds that have suffered so far this year after a stellar 2013 include City Financial UK Income Opportunities, which has a keen small to mid cap focus, as well as Montanaro Equity Income, MGTS Ardevora UK Income and Premier Income.
Experts from Oriel and Numis recently pointed to a sharp correction in small cap trusts as a buying opportunity for long-term investors.
UK All Companies
Similarly, the end of the rally in small and mid caps has had a big impact on the top-performing UK growth funds of recent years.
Two funds in particular have suffered: Unicorn UK Growth and Schroder Recovery.
The funds were the third and fourth best performers in the sector in 2013 and top-quartile performers in 2012 as well.
Unicorn UK Growth has been a top quartile performer in every full calendar year since 2009.
However, a sharp correction in tech stocks – an area which the fund has a big overweight in – has resulted in a loss of 4.28 per cent this year, sending the fund to the bottom of the UK All Companies sector.
Murphy and Kirrage’s Schroder Recovery fund has also suffered, losing 3.44 per cent – hardly surprising as it has a similar focus and many of the same stocks as Schroder Income.
Performance of funds, sector and index in 2014
Source: FE Analytics
It’s hardly a shock to see specialist UK mid cap funds suffer in 2014. The largest and highest profile of these is Andy Brough’s £1.6bn Schroder UK Mid 250 fund, which has lost 4.24 per cent so far this year, having made more than 40 per cent in 2013.
Performance of fund, sector and index in 2014
Source: FE Analytics
Brough has been running the fund since 1999. Over the past decade, Schroder Mid 250 has been top quartile in every calendar year apart from 2007, 2008 and 2011, which gives a clear indication of its propensity to underperform in down or sideways markets.
Global
In the IMA Global and Global Equity Income sectors, four notable funds have fallen from grace: two from Invesco Perpetual and two from Standard Life Investments.
The £112m Standard Life Investments Global Equity Income fund, managed by FE Alpha Manager Kevin Troup, and the £671m Invesco Perpetual Global Equity Income fund, managed by Nick Mustoe, have returned more than the sector average since the beginning of 2013, despite their underperformance this year.
Performance of funds and sector since Jan 2013
Source: FE Analytics
Mustoe recently told FE Trustnet income-seeking investors shouldn’t be tempted back into defensive, bond-proxy areas of the market despite the recent market pull-back, believing the current lukewarm conditions are temporary.
“We think in terms of equity markets, this is a pause and it has been a good opportunity in the fund to add to some of our holdings that have underperformed in this period,” he said.
“We are not rotating into defensive areas. A lot of these bond-proxy stocks look pretty expensive compared to their histories and offer little growth going forward.”
Similarly the Invesco Perpetual Global Opportunities and Standard Life Investments Global Smaller Companies funds have seen flatter performance this year.
Part of this can be explained by their overweights to European equities, which have had a miserable couple of months.
Both funds have lost money in 2014, causing them to drop from the top quartile in 2013 to the bottom this year.
Performance of funds and sector since Jan 2013
Source: FE Analytics
Co-manager of Invesco Perpetual Global Opportunities Stephen Anness has been changing the focus of the fund of late, telling FE Trustnet back in April that the rally in low-quality cyclical stocks was coming to an end.
The FE Alpha Manager says that the recovery phase has all but ended and he doesn’t expect developed world equity markets to re-rate any further – in stark contrast to Mustoe’s comments.
“At this stage in the market cycle, we want to invest where we believe earnings growth is persistent. We believe that future performance will be generated from earnings delivery rather than continued belief in the recovery story.”
