More cynical investors will often talk of mean reversion in the fund management industry – the idea that even the highest-rated and most sought after managers will one day move back in line with their peer groups.
Of course, it must not be forgotten that active managers will almost certainly go through periods of underperformance.
However, there have been a number of “star” managers who – three or so years ago – had topped their respective sectors but now have track record’s which are slightly less spectacular as a result of their style falling out of favour, growing AUMs or poor stock calls.
Therefore, we are starting a new series in which we ask the experts whether these managers’ more recent slide is part of a longer term trend or whether they are due a rebound – starting with the UK equity sectors.
It must be noted that these funds have all outperformed over the longer term and have by no-means delivered disastrous returns, but their numbers over time frames such as three, five or 10 years now look more average than they once did.
Standard Life UK Smaller Companies
We start with Standard Life UK Smaller Companies, which has been headed-up by veteran small-cap manager Harry Nimmo since its launch in 1997.
According to FE Analytics, the FE Alpha Manager “hall of famer” has delivered the second highest returns in the sector over that time and has beaten his average peer by more than 400 percentage points.
It is a similar story over 10 years as his Standard Life fund sits firmly in the top quartile in the sector with returns of 275.81 per cent.
However, over more recent years that performance has started to wane. While Nimmo, with his focus on growth, was top quartile in four out of the five calendar years between 2005 and 2009 – over the past five calendar years his fund’s returns have been more average.
Source: FE Analytics
Rob Morgan, pensions and investment analyst at Charles Stanley Direct, describes as Nimmo as an “excellent stockpicker” but says there may be a number of factors why the fund has started to struggle; such as its AUM which now stands at £1.1bn.
“It’s quite interesting the fund has enjoyed its best periods of performance when the fund size was smaller. Over time the fund has migrated up the cap scale as assets have built and Nimmo has invested in small caps that have become mid-caps and – in the case of Hargreaves Lansdown – FTSE 100 stocks,” Morgan said.
“This was of course a deliberate policy of running winners such as ASOS, but building meaningful positions in smaller firms is more difficult with a larger fund without bringing about undue liquidity risk, and it can mean some good small cap stock ideas are not capitalised on as much as they would be in a smaller portfolio.”
Ben Conway, fund manager at Hawksmoor, says it is difficult to call whether Nimmo will replicate his stellar past returns in the future and is therefore looking at other options in the space.
“It is true that high quality managers don’t become bad overnight and normally if a manager has gone through a period of underperformance it can be seen as a blip because their style is out-of-favour and is actually a good time to buy,” Conway said.
“However, I don’t know if that is the case with this fund. I suspect the underperformance is much more to do with the size than anything else.”
"When you look at its performance over recent years, it has been ok, but is a classic example of a fund struggling to keep pace with its index and peers – and that’s maybe because he can’t get access to certain parts of the market.”
This fund has been run by FE Alpha Manager Derek Stuart since its launch in March 2000 and has a very strong long-term track record.
According to FE Analytics, it has been the second best-performing fund in the IA UK All Companies sector with returns of 453.33 per cent, beating the FTSE All Share by a hefty 350 percentage points in the process.
The major drivers of those returns were Stuart’s early years on the fund, when his stock-picking skills and focus on unloved businesses stood him in good stead as the wider market reeled from the bursting of the “dot-com” bubble.
Our data shows, for example, that the fund made a staggering 65.82 per cent in the remaining nine months of 2000 when both the sector and index lost money. It was also top decile in 2001, 2002 and 2003, fell into the second quartile in 2004 and was once again top quartile in 2005.
However, since then, it hasn’t posted top quartile returns in a full calendar year. While it is hardly struggling, those performances mean the fund’s returns over one, three, five and 10 years are much more in line with those of the sector or index.
Performance of fund versus sector and index over 10yrs
Source: FE Analytics
Morgan says that, like Nimmo, Stuart has had to deal with a growing AUM (it currently stands at £1.2bn) which will have meant he has had to “migrate” up the market cap-spectrum over recent years for liquidity purposes.
However, he says that investors in the fund should have no reason to sell given that Stuart is an accomplished stockpicker and is running a genuinely active fund.
This argument is supported by the team at Square Mile, who have given the fund a AA-rating.
They point out that periods of underperformance are almost a certainty with the Artemis fund given that Stuart concentrates on “companies that are out of favour with the wider market, often because something has gone wrong with the company”.
Therefore, they say investors need to be patient with the Stuart and expect him to be back in the top quartile sooner rather than later.
“The process is a sensible one but from time to time the manager is likely to find himself out of step with trends in the market and the fund may suffer an extended period of underperformance.”
“However, the focus on undervalued situations in sustainable businesses has helped limit the volatility of the fund's performance and the fund's risk profile compares well to its peers despite the above average exposure to small and mid-caps.”
“Investors may occasionally require patience with the fund but Stuart is an astute investor who we believe will continue to deliver solid returns to the holders of this fund.”
Investec UK Special Situations
The final fund in this article is Investec UK Special Situations, which is headed by arguably the most renowned contrarian manager available to investors, Alastair Mundy.
Mundy has a relatively unique approach to UK equities as he looks for “companies whose shares have underperformed by at least 50 per cent relative to the market from the price peak over the previous seven years, where sentiment is poor and where they perceive there to be significant value”, according to Square Mile.
This approach means the fund has comfortably outperformed both the sector average and the FTSE All Share since Mundy took charge in August 2002 with returns of 248.66 per cent.
However, its outperformance is much narrower over more recent time frames.
Our data shows that while it has beaten the index over these periods, it is second quartile over 10 years and third quartile over three and five years. It is also bottom quartile and down against its benchmark over 12 months.
Performance of fund versus sector and index over 5yrs
Source: FE Analytics
On a discrete calendar basis, Investec UK Special Situations has underperformed against the FTSE All Share in four out of the last 10 years and underperformed against the sector average in six.
A number of reasons have been given for Mundy’s relatively lack-lustre returns of late, such as his high weighting to cash, a short position on the roaring S&P 500 and stock specific issues such as buying supermarkets too early last year.
However, experts tend to agree that his underperformance has mainly been due to his focus on value, more than anything else.
For example, Saunderson House’s Ben Williams recently told FE Trustnet that he wasn’t concerned by Mundy’s recent underperformance and said that as he has proven himself in falling markets – such as 2008 and 2011 when the fund was top decile – he is happy to keep hold of the fund and even add more to it.
Morgan agrees with Williams’ assessment and says investors certainly shouldn’t be selling now.
“It is typical for Mundy to underperform in a bull market. Much of his relative long term outperformance came in 2007/8 when he (quite rightly) adopted a conservative stance and built a cash position,” Mundy said.
“His contrarian style will I’m sure have its time again, but in the recent past the market environment hasn’t favoured him with the valuation gap between “expensive” and “cheap” parts of the market getting wider.”
