MFM Slater Growth, Invesco Perpetual UK Strategic Income and Unicorn UK Income are some of the UK equity funds that have posted the highest Sortino ratios over the eight years of the market cycle, according to research by FE Trustnet.
Although the Sharpe ratio is one of the most commonly used metrics for risk-adjusted returns, Sortino is seen as a better tool for analysing investments in more volatile conditions.
The Sortino ratio was developed in 1983 and was named after Frank A. Sortino, who was an early populariser of downside risk optimisation. It is a modification of the Sharpe ratio and differentiates ‘bad’ volatility from general volatility by taking into account the standard deviation of negative asset returns, or downside deviation.
For those with a yearning to see the maths behind the ratio, here it is:
Source: FE Analytics
Colin Moore, the global chief investment officer of Columbia Threadneedle Investments, recently called on investors to pay more attention to this potentially overlooked metric, as he expects volatility to be higher over the coming years than it has been over the past decade.
“The volatility bogeyman will appear more often,” he said. “Many portfolio construction optimisation tools use historical average volatility, which is likely to underestimate the volatility investors will face. The bogeyman emerges when individual asset class volatility spikes and cross-correlations rise, the combination of which increases overall portfolio volatility far beyond expectation.”
“Diversification is meant to protect investors against volatility, but what’s the point of owning lots of investments if the volatility bogeyman has not been properly estimated? The Sortino ratio, which differentiates spike volatility from general volatility, needs to be used more.”
With this in mind, FE Trustnet looked at the IA UK All Companies and IA UK Equity Income sectors to see which funds are leading the pack for Sortino over the last eight years. The top 10 funds, along with their eight-year return, are shown below.
Source: FE Analytics
As well as having the highest Sortino ratios of their 269-strong peer group, all of the above funds are in the top decile for total returns over the eight-year period.
MFM Slater Growth, which is headed by FE Alpha Manager Mark Slater, is in top spot for returns as well as Sortino, after making 218.29 per cent over the period looked at in this study. The five FE Crown-rated fund take an unconstrained, growth-orientated approach to investing and has a bias towards smaller companies in its portfolio.
This is apparent when other metrics are looked at. MFM Slater Growth sits in the sector’s third quartile for both annualised volatility (at 16.13 per cent) and maximum loss (at 27.56 per cent), reflecting the fund’s concentrated portfolio and presence in ‘riskier’ parts of the market.
Indeed, not all the funds in the list are among the sector’s best when it comes to volatility. The three mid-cap funds – Royal London UK Mid-Cap Growth, Franklin UK Mid Cap and Old Mutual UK Mid Cap – are all in the ninth or tenth decile on this count and have been more volatile than the FTSE 250 over the past eight years, but with strong outperformance.
Performance of funds vs sector and index over 8yrs
Source: FE Analytics
All the other funds in the top 10, however, are in the IA UK All Companies sector’s top three deciles for annualised volatility and they are led by FE Alpha Manager Mark Barnett’s Invesco Perpetual UK Strategic Income fund.
Barnett’s approach combines bottom-up stock selection with analysis of the macro environment and the manager pays close attention to capital preservation. An example was in the financial crisis, when his avoidance of banks paid off; as a result the fund has one of the lowest maximum drawdowns in the peer group.
Of course, Invesco Perpetual UK Strategic Income was formerly a member of the IA UK Equity Income sector and the 10 funds from this peer group with the highest Sortino ratio relative the FTSE All Share can be seen below.
Source: FE Analytics
Again, the fund with the highest Sortino – Unicorn UK Income – is the one posting the highest total return over the period in question. Managed by Fraser Mackersie and Simon Moon, this five FE Crown-rated fund is another that focuses on smaller companies, which offer the potential for strong long-term returns but often gives investors a more volatile ride.
MI Chelverton UK Equity Income and Montanaro UK Income are other funds that have a high Sortino ratio, but have been more volatile than their average peer thanks to their preference for looking outside of the typical dividend stalwarts and investing further down the market-cap spectrum.
The fund that has given investors the smoothest ride over the eight years of the past market cycle is FE Alpha Manger Francis Brooke’s Trojan Income, with annualised volatility of 10.21 per cent (against the FTSE All Share’s 14.77 per cent).
Brooke prefers predictable businesses that generate substantial levels of cash and attempts to avoid those that may face problems in the future, no matter how well they are performing at the moment. Like other funds run by Troy Asset Management, there’s also a heavy focus on capital preservation.
Performance of funds vs sector and index over 8yrs
Source: FE Analytics
Flipping things on their head and FE Analytics shows that the IA UK All Companies funds with the lowest Sortino ratios have been Halifax Special Situations, Scottish Widows UK Select Growth, Family Charities Ethical, IFSL Trade Union Unit Trust and VT Smart Dividend UK.
In the IA UK Equity Income sector, it’s Scottish Widows UK Equity Income, Henderson UK Strategic Income, UBS UK Equity Income, Halifax UK Equity Income and F&C UK Equity Income that come in bottom place for this metric.