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Most active funds underperform – but do most investors?

06 October 2014

It’s a common argument that most fund managers fail to beat the index over time, but most UK investors are in funds with a history of outperformance.

By Gary Jackson,

News Editor, FE Trustnet

Neil Woodford recently rattled the investment world by arguing that too many active managers are guilty of making index-like returns, but research by FE Trustnet suggests the majority of UK equity assets are held in funds that, on average, beat the market.

Speaking last month to BBC Radio 4’s Today programme, the UK equity income veteran said: “Too often the industry has been guilty of charging active fees for index performance or worse.”

“Many active fund managers probably would like to have the freedom to express their fund management talent in their portfolios but are constrained by the fear that if they were to underperform the index for a three, six [or] 12-month period then their careers would be in jeopardy.”

Of course, the argument over how much value active managers actually add for their higher fees and whether investors would be better off settling for market returns through an index tracker is hardly new.

Performance of sector vs index over 10yrs

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Source: FE Analytics

Last month’s issue of FE Investazine looked at both sides of the active versus passive debate.

Passive fans argue that no active manager can consistently beat the market while those in the active camp say the advantages of stock selection, bottom-up fundamentals and macro analysis justify the higher fees.

The below study by FE Trustnet won’t end the debate about the relative merits of an active or passive approach, as both can serve investors well.

Instead, it attempts to show that while the average active manager may find it difficult to consistently beat the market, the average investor is invested with those that can.

We’ve focused on IMA UK All Companies – the largest sector in the IMA universe.

There will of course be exceptions, but the vast majority of UK investors will have at least one of its members in their portfolio.

Also, the sector’s 275 funds approach UK equities in a variety of ways, suggesting freedom to deviate from the FTSE All Share and the environment for true active management to show itself.

Active management often entails periods of out- and under-performance, but an investor hopes the right calls will outweigh the wrong ones over the long term.

With this in mind, the study concentrates on the annualised return of active funds over the past 10 years to show the average outcome for investors.

Over the past 10 years, the FTSE All Share has made an annualised return of 8.21 per cent.

Our analysis shows the average active fund in the IMA All Companies sector has achieved an annualised return of 8.37 per cent - which is outperformance but hardly to the extent that would justify the higher fees of active management.


What’s more, only 73 active funds out of the 151 with 10-year track records beat the All Share in terms of annualised returns.

This means slightly more – 78 – have failed to match or beat the market.

In all, 34 funds have made returns averaging more than 10 per cent a year over the decade while four have made less than 5 per cent.

These funds are Family Charities Ethical, UBS UK Opportunities, Halifax Special Situations and Sovereign Ethical.

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Source: FE Analytics

On its own this could be a damning indictment of the UK All Companies peer group, as more than half of the sector seems to have trouble beating the index on average.

It certainly backs up the passive advocates’ argument that the average manager will struggle to generate returns higher than the market – especially as the figures don’t take into account survivorship bias.

However, the story doesn’t end here.

We were interested in the outcome experienced by the average investor, not how the average fund has performed. After all, many of the worst performing funds have only a few million pounds invested. Instead, the size of funds also has to be taken into account.

Putting performance into the context of asset invested, our data shows that the majority of actively managed assets in the sector are held within funds that have a track record of beating the All Share.

FE figures show that 68.9 per cent of money – or £67.2bn – sits in UK All Companies funds that have outperformed, while 31.1 per cent of money is in those that have delivered less than the index on average.

Investors naturally want to be in the funds that offer the best returns.

While this may lead to some undesirable behaviour such as performance chasing or successful funds become too bloated after mass inflows, it’s clear that funds with a record of beating the index will tend to attract and hold on to investor assets.

Our analysis reveals the average fund that has beaten the All Share in annualised terms over the past decade has assets of £920.9m. The average underperformer, meanwhile, is just £388.5m in size.

Large funds in the outperforming bucket include Invesco Perpetual High Income, AXA Framlington UK Select Opportunities and Fidelity Special Situations.

The underperforming average is pulled up by large funds such as Halifax UK Growth and Scottish Widows UK Growth.


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Source: FE Analytics

Critics will rightly point out that a large proportion of the outperformers’ assets will have been handed to the funds after periods of strong performance, not before.

However, looking at FE’s historical data, it’s clear that many of the larger funds were hardly minnows a decade ago.

Invesco Perpetual High Income, which has achieved annualised returns of 11.49 per cent, most of which under the leadership of Woodford (pictured), was £4.95bn in December 2005, which is as far back as our data goes.

ALT_TAG Fidelity Special Situations was £6bn and AXA Framlington UK Select Opportunities was £684.4m.

While these funds are obviously much bigger today than they were in the past, let’s also remember that the investment universe is much larger now.

For example, Invesco Perpetual High Income is responsible for 1.79 per cent of assets in the IMA universe; in December 2005 it oversaw a still significant 1.43 per cent of the universe.

In addition, the record of active funds looks much better when comparing them to tracker funds.

After all, an investor can’t just buy the market – they have to go through a passive vehicle, which carry fees of their own.

We re-ran the numbers to see the proportion of assets that beat the £1bn HSBC FTSE All Share Index fund over the period.

This fund was chosen because it is one of the cheapest and largest available to UK investors with ongoing charges of just 0.17 per cent. It is also one of the few with a 10-year track record.

The tracker has made an annualised return of 7.58 per cent over the decade in question, underperforming the index net of fees as expected.

Some 75.1 per cent of the actively managed funds have beaten the tracker, leaving just 25.9 per cent of assets that would have been better off in an indexed product.

Simon Evan-Cook, an investment manager at Premier Asset Management, believes active management can outperform over the long term but adds that the UK sector is blighted by a number of large funds that offer little better than index-like returns.


“When it comes to the weight of assets in underperforming funds, the main culprit to me is the type of fund that isn’t marketed to my peer group or put on platforms but purely sold directly through large distribution networks,” he said.

“You’ll find trackers charging 1 per cent and funds that are barely active being sold at 1.5 per cent. That murky section where funds are between real trackers and genuinely active funds is a real problem, where I think clients are being ripped off.”

As mentioned above, this is far from a perfect study. Some of the funds have seen manager changes over the years, survivorship bias has skewed some of the results and active managers may have years of great outperformance followed by others where their style failed to beat the market.

Hopefully the study adds a different perspective to the view that most investors in active funds are being taken for a ride.

Later in the week we’ll go one step further, looking at the proportion of money in the UK’s most popular funds that has actually outperformed the market.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.