CF Lindsell Train UK Equity, Neptune UK Mid Cap and Rathbone Income are among the most consistent UK funds for their risk-adjusted returns over the past five years, according to the latest FE Trustnet study.
Active managers are often likened, by some of the more cynical and dogmatic passive enthusiasts, to blindfolded monkeys randomly picking stocks, but even those without this view will agree that luck can certainly play a part in a manager’s outperformance.
Also, while investors will always want their fund manager to beat the wider market, they will no doubt want to make sure their savings aren’t being put at too much risk in the process.
One way investors can measure a fund’s performance from a risk-adjusted perspective, however, is by analysing its Sharpe ratio – which is a metric used by the large majority of research groups to calculate an active manager’s ability.
Indeed, it is one of the key measures when the FE Alpha Manager ratings are worked out.
“The Sharpe ratio is a useful measure of the return a manager generates per unit of risk taken on,” Thomas McMahon, fund analyst at FE Research, said.
“A higher Sharpe ratio implies that the manager does a better job of turning the volatility of the fund into positive returns. If two fund managers have the same returns but one has a higher Sharpe, that manager has achieved the returns by taking on less risk, which is obviously preferable.”
McMahon notes that the Sharpe ratio is not perfect, however, and therefore shouldn’t be used in isolation when assessing a fund’s potential.
“Like any quantitative measure it is backward-looking, so investors shouldn’t assume that the same patterns will persist into the future and the managers will generate the same Sharpe. In particular, because the Sharpe ratio uses standard deviation in the denominator it assumes asset returns are normally distributed which evidence suggests they are not.”
“This means it is not precisely capturing all the risk inherent in the market.”
Nevertheless, there is little doubt that managers who have demonstrated an ability to beat the wider market without taking undue levels of risk should be congratulated – especially if they have done it in varying market conditions.
With that in mind, FE Trustnet takes a closer look at the funds within the IA UK All Companies, IA UK Equity Income and IA UK Smaller Companies sectors which have outperformed in terms of their Sharpe ratio in each of the last five calendar years.
UK All Companies funds
According to FE Analytics, there are some 14 funds within the highly competitive IA UK All Companies sector to have delivered either first or second quartile risk-adjusted returns in 2010, 2011, 2012, 2013 and 2014.
However, to whittle down the list, we will look at the only three funds within the sector to have sat in the top 25 per cent for their risk-adjusted returns in each of those years; namely CF Lindsell Train UK Equity, Aviva Inv UK Equity Manager of Manager and Neptune UK Mid Cap.
Regular readers of FE Trustnet will know by now just how consistent the five crown-rated CF Lindsell Train UK Equity fund has been over the long term.
Under the stewardship of FE Alpha Manager Nick Train, the now £1.5bn fund has delivered top quartile returns and beaten its FTSE All Share benchmark in each of the last seven calendar years – which include some very strong rising and falling markets.
Source: FE Analytics
However, while Train has a highly concentrated portfolio of usually less than 30 stocks, he has achieved those returns without exposing his investors to a high level of risk.
As a result of Train’s low turnover approach – which leads him to focus on high quality, cash generative businesses with strong franchises – and his performance profile, his fund sits on the FE Select 100 and carries Square Mile’s highest AAA rating.
Train also partly manages another fund on the list, the five crown-rated Aviva Inv UK Equity Manager of Manager.
The portfolio is split between four fund houses; Lindsell Train, Investec, Baillie Gifford and Standard Life and has been top quartile for both its total returns and risk-adjusted returns in each of the five years in question.
The other fund to have achieved the enviable feat of posting top quartile Sharpe ratios in each of the last five years is FE Alpha Manager Mark Martin’s five crown-rated Neptune UK Mid Cap fund, which is also a member of the FE Select 100.
However, while the fund has also comfortably beaten the sector in each of those years, it has actually underperformed against its FTSE 250 ex IT benchmark in two of them – namely the strongly rising markets of 2009 and 2013.
That, though, is due to Martin’s focus on capital protection as his “three silo” approach to portfolio construction means he can lag behind when the market is rallying, but come into his own when the index is flat or falling.
Data from FE Analytics shows, for example, that the fund made 12 per cent last year when the index was up just 3 per cent and in 2011, when the European sovereign debt crisis intensified and the FTSE 250 fell 10 per cent, Martin delivered a 3.65 per cent return to his investors.
UK Equity Income funds
Unlike in the UK All Companies sector, no IA UK Equity Income fund has been top quartile for its Sharpe ratio in each of the last five calendar years. However, four have come very close.
One of which is Carl Stick’s five crown-rated Rathbone Income fund which was top quartile for its risk adjusted-returns in 2010, 2011 and 2014 but fell into the second quartile in 2012 and 2013.
Nevertheless, the manager is renowned for his focus on capital preservation as he aims to reduce the likelihood of capital loss by assessing a company’s business risk, financial risk and the price risk when determining its valuation.
Stick is one of the highest rated equity income managers going and his £1bn fund has been the sector’s best performing portfolio since he took charge in January 2000 with returns of 282.65 per cent.
Performance of fund versus sector and index since Jan 2000
Source: FE Analytics
Though the fund went through a very difficult period during the financial crisis, Stick has since rebounded and outperformed the FTSE All Share in each of the last five calendar years.
The other funds to have outperformed in terms of their Sharpe ratio in each of the last five years include Richard Colwell and FE Alpha Manager Leigh Harrison’s Threadneedle UK Equity Income and UK Equity Alpha Income funds.
The other portfolio to have achieved the feat, despite the fact it is a fund of funds, is HL Multi Manager Income & Growth. However, the £1bn fund was only top-quartile for its Sharpe ratio in 2013 and 2014.
UK Smaller Companies funds
Given that the IA UK Smaller Companies sector is considerably smaller than both its IA UK All Companies and IA UK Equity Income equivalents, it is only natural that fewer of its funds have delivered consistent risk-adjusted return outperformance, on a relative basis, over the past five years.
In fact, the only retail focused small-cap portfolio to have achieved either second or first quartile Sharpe ratios over that time is the five-crown rated AXA Framlington UK Smaller Companies fund.
According to FE Analytics, its Sharpe ratio was top quartile in 2011, 2013 and 2014 and second quartile in 2010 and 2012.
While it has underperformed against its FTSE Small Cap ex IT benchmark in strongly rising markets like 2012 and 2013, it has comfortably beaten the index in more turbulent markets.
In 2011, it fell less than 1 per cent compared to the 15 per cent drop in the wider market and even made more than 6 per cent last year when small-caps were in negative territory.
It must be noted, however, that the fund has only been run by Henry Lowson since May 2012.
Performance of fund versus sector and index since May 2012
Source: FE Analytics
Nevertheless, it has beaten its benchmark and been top decile for its total return and risk-adjusted returns over that time.