MFM Slater Growth, Marlborough UK Multi-Cap Growth, Royal Bank of Scotland Equity Income and Old Mutual UK Smaller Companies Focus have delivered some of their sectors’ best risk-adjusted and absolute returns over the past decade while remaining at a nimble size, the latest FE Trustnet study shows.
A persistent trend in the asset management space is for successful funds to attract a swell of assets, which then threatens to bring their days of outperformance to an end. Although there are examples of many managers who have been able to easily run large sums of money, some investors prefer smaller funds that can be more flexible.
Lucy Walker, fund of funds manager at Sarasin & Partners, recently cautioned investors about flocking to flagship portfolios when she highlighted several fund selection myths to avoid.
“We would say that not all large funds are necessarily going to outperform and part of the reason for that is that bigger funds find it more difficult to invest in the things that perhaps found helped them in the early years,” she explained.
“This might be rotation in and out of sector or an overweight to small-cap – those kind of things become more difficult the bigger and bigger funds become. We would say that rather than viewing these funds as safe we should consider them as having a bit of detriment towards them.”
To identity smaller funds with a history of outdoing their larger rivals, we screened the sector for portfolios with assets of less than £300m, a track record of more than 10 years, first quartile returns over this time frame and top-decile risk-adjusted returns, as measured by the Sharpe ratio.
Just eight funds from the Investment Association’s UK All Companies, UK Equity Income and UK Smaller Companies sectors made the grade. In the below article, we take a closer look at these portfolio.
IA UK All Companies
Within the Investment Association’s largest sector by assets, FE Alpha Manager Mark Slater’s £187m MFM Slater Growth fund stand out as a consistent outperformer with total returns of just under 300 per cent over the past decade.
As a point of comparison, the FTSE All Share has made 126.45 per cent over this time frame while the average fund in the IA UK All Companies sector has trailed just behind with a 121.84 per cent gain.
Performance of fund vs sector and index over 10yrs
Source: FE Analytics
The fund also scores highly on other metrics, boasting the peer group’s highest alpha score over the past decade, at 7.57, as well as top-decile Sharpe, Sortino and Treynor ratios and the fewest negative months. However, it must be noted that it has experienced a higher maximum drawdown and a greater annualised volatility than its average peer.
MFM Slater Growth tends to invest further down the market cap spectrum, as does the next fund on the list: James Thorne and Matt Evans’ £106.6m Threadneedle UK Mid 250, which has posted a 253.47 per cent 10-year return. Its Sharpe ratio over the period has been 0.57, compared with Slater’s 0.66.
Marlborough UK Multi-Cap Growth, which is headed by FE Alpha Manager Richard Hallett, appears in the third place for risk-adjusted returns with a 0.44 Sharpe ratio and a 10-year total return of 205.64 per cent. Close to 40 per cent of the £88.9m portfolio is in mid-caps, but it has 25 per cent in large-caps and almost 20 per cent in mega-caps.
The other small IA UK All Companies members with top-decile Sharpe ratios and 10-year outperformance are FE Alpha Manager Margaret Lawson and Colin McLean’s £105.5m SVM UK Growth, FE Alpha Manager Andrew Jackson’s £190.8m Ecclesiastical UK Equity Growth and Chris Kinder’s £64.5m Threadneedle UK Extended Alpha funds.
All of the above funds have decent weightings to FTSE 250 stocks, although – aside from Threadneedle’s dedicated mid-cap portfolio – they do not shy away from large-caps.
This willingness to invest further down the cap spectrum could explain their good risk-adjusted returns, as the FTSE 250 has risen 130 percentage points more than the FTSE 100 over 10 years but with annualised volatility just four percentage points higher, at 17.15 per cent.
IA UK Equity Income
Only one portfolio from this popular sector has assets of less than £300m with a top-decile risk-adjusted returns – the four FE Crown-rated Royal Bank of Scotland Equity Income fund, which is managed by Aviva’s Chris Murphy. This £71m fund has returned 156.38 per cent over 10 years with a Sharpe ratio of 0.45.
Royal Bank of Scotland Equity Income has also performed better than its average peer on most metrics available on FE Analytics, including alpha, annualised volatility, maximum drawdown, maximum gain and downside risk.
Performance of funds vs sector and index over 10yrs
Source: FE Analytics
Murphy has almost 70 per cent of assets in the large and mega-cap parts of the market, with just over 21 per cent in mid-caps and 8.3 per cent in small-caps. Rio Tinto is the largest holding, followed by GlaxoSmithKline and Vodafone Group.
The fund is only available through Royal Bank of Scotland, meaning not all investors will find it easy to add to their portfolios. Another small fund in the sector has managed to outperform its peers for risk-adjusted and absolute returns, although it is not in the top decile.
The five FE Crown-rated Old Mutual UK Equity Income fund has been managed by Stephen Message since the end of 2009, having been previously helmed by Michael Gifford. The £162.2m fund has a 10-year Sharpe ratio of 0.34 and has posted a 139.59 per cent total return.
Message attempts to build a differentiated portfolio from his peers and recently told FE Trustnet why he has double the average exposure to financials, which account for 42 per cent of his assets.
“There’s one sector in the market where dividends are low or they’re not being paid and that’s the banking sector. Banking won’t typically fall onto an income investor’s radar because the dividends, in the case of Lloyds and RBS, are just not being paid while in the case of Barclays, they’re quite low,” the manager said in January.
“But I think you need to look a few years out because the dividend potential of those companies is significant. I think Lloyds will return to the dividend register this year and I think the dividend payout ratio at Barclays can rise a fair bit.”
Lloyds indeed did go on to announce that it will resume dividend payments for the first time since the 2008 financial crisis, saying in February that it will pay a dividend of 0.75 pence per share.
IA UK Smaller Companies
Again, only one member of this sector has assets under £300m with a top decile Sharpe ratio and it’s another fund from Old Mutual Global Investors.
The five crown-rated £135.8m Old Mutual UK Smaller Companies Focus fund, which is headed by FE Alpha Manager Daniel Nickols, has returned 309.62 per cent over 10 years with a Sharpe ratio of 0.65 – the highest in the peer group.
Performance of funds vs sector and index over 10yrs
Source: FE Analytics
This is not the only metric where the fund leads the pack as FE Analytics shows it’s also in first place when it comes to alpha, relative return, Sortino ratio and Treynor ratio over the past decade. What’s more, it’s been the best performing fund in the sector on a 10-year view.
Old Mutual UK Smaller Companies Focus is also a member of the FE Research Select 100, where its approach of combining fundamental stock analysis with macroeconomic factors is noted.
“Since Nickols also takes into account the macroeconomic environment and the business cycle, the fund’s performance is not dependent on his stockpicking skills alone,” the FE Research team said.
“This diversity of performance sources should help the fund to generate above-average risk-adjusted returns over the long term. Short periods of underperformance are possible, but in such scenarios, FE expects Nickols to quickly adjust his portfolio in order to improve performance.”