FE Trustnet has highlighted the problems of investing in a global basis on a number of occasions. A study last year, for example, found that more than 80 per cent of IA Global members had failed to beat the market over the previous three years.
The picture was only slightly better when the sector was looked at a five-year horizon, with just 24.6 per cent of funds proving themselves able to outperform the MSCI AC World index.
FE Analytics backs up the view that the IA Global sector, which has 291 members and is the second largest peer group with total assets of £77.5bn, has a poor track record in beating the market.
As the graph, below shows the average fund in the sector has underperformed the MSCI AC World by almost 20 percentage points over the seven years of the past market cycle.
Performance of sector vs index over 7yrs
Source: FE Analytics
The same is also true over more recent time frames. The IA Global average return over five years is 57.73 per cent while the MSCI AC World rose 68.52 per cent; over three years the sector gained 36.72 per cent but the index was up 43.18 per cent.
However, our research shows funds with a more concentrated portfolio have been able to beat the index and the sector average over the past seven years as well as the over the two more recent time frames.
We created two equally weighted portfolios: one holding the 15 pure-equity funds with highest weightings in their top 10s and one with 15 global funds with the lowest concentration in the top 10s. All the funds included have a track record of at least seven years.
Over the last market cycle, the most concentrated portfolio – which includes the likes of Baillie Gifford Long Term Global Growth, Trojan Capital and First State Worldwide Leaders – has returned almost 80 per cent.
This is over five percentage points more than the MSCI AC World and 25 percentage points more than the average return in the IA Global sector.
Performance of portfolio vs sector and index over 7yrs
Source: FE Analytics
The concentrated funds stay on top of the index and the sector over three and five years by a good margin. However, over one year – which includes the bulk of 2014, where progress was difficult because of geo-political risks and worries over rate rises – they did underperform the market.
Laith Khalaf, senior analyst Hargreaves Lansdown, said: “A concentrated portfolio has a better chance of outperforming if it is run by a talented fund manager, but the potential for underperformance is greater if not.”
“What these figures suggest to me is that only more promising investment managers are given the freedom to run a concentrated portfolio and this shines through in superior investment performance.”
Interestingly, the most diversified portfolio was also able to outperform the MSCI AC World over three, five and seven years. Over three and five years, the returns were broadly similar to the concentrated funds but they do lag by a wider margin on a seven-year view.
Performance of portfolio vs sector and index over 7yrs
Source: FE Analytics
The outperformance of the average diversified fund can be explained by the inclusion of those looking further down the market-cap spectrum, such as Schroder ISF Global Smaller Companies and Invesco Perpetual Global Smaller Companies, where the chances of higher returns are greater.
The most diversified fund in the portfolio is Dimensional International Core Equity. The portfolio holds 4,608 securities (its benchmark only includes 1,525 stocks) and tends to be overweight smaller companies.
Back to the most concentrated portfolio and our data shows that it has not only returned more than the MSCI AC World over the seven years of the market cycle, but it has given investors a much smoother ride.
According to FE Analytics, the annualised volatility of the average concentrated fund over seven years is 14.48 per cent. This compares to 15.49 per cent for the index and 16.13 per cent for the diversified portfolio.
Maximum drawdown among the concentrated funds is 28.40 per cent, against 32.03 per cent in the MSCI and 33.34 per cent for the most diversified members of the peer group. The average Sharpe ratio, which is a measure of risk-adjusted returns, of the concentrated portfolio is 0.38 over seven years compared with 0.31 for the diversified offerings.
What’s more, the concentrated portfolio has a lower annualised volatility, smaller maximum drawdown and higher Sharpe ratio than the diversified funds, while being less volatile and encountering a lower maximum loss than the index.
A number of highly rated funds are also among the IA Global sector’s most concentrated portfolios, with Baillie Gifford Phoenix Global Growth, CF Odey Opus, First State Global Listed Infrastructure, Invesco Perpetual Global Opportunities, MFS Meridian Global Concentrated and Morgan Stanley Global Brands being headed by FE Alpha Managers.
Three of the funds – First State Global Listed Infrastructure, Invesco Perpetual Global Opportunities and M&G Global Basics – also have a place on the FE Research team’s Select 100 list of preferred funds and hold at least four FE Crowns for superior performance in terms of stock picking, consistency and risk control over recent years.