Some 22 global equity funds outperformed their benchmarks with high tracking errors, potentially indicating that these managers were not afraid of deviating from the global index in a bid to deliver excess returns.
The last five years has been a wild ride for global equity markets. They pushed on upwards through a Brexit referendum, a Trump presidency, 2018’s ‘Volmageddon’ extreme volatility spike and a global pandemic.
Despite the ups and downs, global equities delivered good returns for those who remained invested throughout the last five years, with the MSCI World index’s total return standing at 91.67 per cent over the period.
While the global stock market seemingly continues its steady trend upwards, investors looking at the wide variety of choices in the global fund space may be growing cautious of the old saying, ‘everybody is a genius in a bull market’.
The risk investors now face is picking an active fund hugging the index at the end of a fantastic bull run and paying active fees for it.
As such, Trustnet looked at the performance of all the funds in the IA Global sector to single out those that managed to deliver strong returns whilst also diverging from the global equity index. This was done by looking at tracking error.
Tracking error measures the consistency of excess returns – which can be an indication of how consistently a manager outperforms or underperforms the benchmark. The lower the tracking error, the closer the manager follows the benchmark; the higher the tracking error, the more the manager deviates from the benchmark.
Below are all the IA Global funds with five-year performance record, narrowed down to those that outperformed by more than 10 per cent and had a tracking error above 2. It is ranked by their outperformance of the benchmark.
Funds that do not have a stated benchmark were assessed relative to the MSCI World, which is the most common benchmark in the sector.
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Source: FE Analytics
Correlation (which measures the strength of the relationship between the fund’s performance and the benchmark), and R-squared (which measures to what extent the variance of the benchmark performance explains the variance of the fund performance) are also shown.
Of the 258 global equity funds with five-year track record, the average tracking error was 1.73, while the average correlation was 0.90 and the average R-squared was 0.82.
Of the 22 funds in the table, four are run by Baillie Gifford, with the active fund with the highest level of outperformance on the list being the £592m Baillie Gifford Global Stewardship fund.
It is no surprise that Baillie Gifford funds are the most common on the list, given the firm’s long-term, benchmark agnostic approach to investing in what it calls ‘Actual Investing’.
The group’s other three funds on the list were Baillie Gifford International, Baillie Gifford Global Alpha Growth and Baillie Gifford Global Discovery.
The £2.4bn Baillie Gifford Global Discovery fund was what one manager labelled as the firm’s “secret sauce” in that it focuses on finding the immature businesses that could potentially be the long-term holdings within the Baillie Gifford fund suite. It had the highest tracking error of those on the list, indicating the greatest deviation from the index.
Morgan Stanley was the next most common investment house featured, with three funds making it to the list.
The $2.1bn Morgan Stanley Global Opportunities fund was the second highest outperformer. Run by FE Alpha Manager Kristian Heugh, it also takes a long-term growth approach to investing.
The $1bn Morgan Stanley Emerging Leaders Equity fund and the £1.3bn Morgan Stanley Global Brands fund also both follow a similar long-term approach.
The £8.2bn Lindsell Train Global Equity fund was another notable entry on the list, which is not surprising given its long-term approach and higher weighting to UK equities relative to the index.
Three smaller companies equity strategies made the list, namely the £1.5bn ASI Global Smaller Companies fund, the £35m Liontrust Global Smaller Companies fund, and the €990m Kempen (Lux) Global Small-cap fund.
Small-caps are often an under researched area of the market with many constituents in the index, meaning that a fund that takes concentrated bets with conviction will have a high tracking error and potentially outperform.
Active share, which measures the percentage of stock holdings in a manager's portfolio that differs from the benchmark index, could have been a better measure if its availability were more widespread.
The Baillie Gifford Global Stewardship fund for example, has a high tracking error of 3 and understandably has a high active share of 89 per cent.
Whereas the Lazard Global Strategic Equity fund, an active value strategy with the same benchmark and a seemingly low tracking error of 0.98 but has a high active share of 87 per cent.
But a high tracking error isn’t always indicative of high returns, as the metric just looks at differences between a fund and an index. Obviously, a fund can look very different to the index and underperform it – sometimes by a wide margin.
Below are 20 funds with a tracking error above 2 that underperformed their benchmark by more than 10 per cent.
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The €16.1m JGF-Jupiter Global Ecology Growth fund came out the worst, after underperforming its FTSE ET100 benchmark by 140 percentage points. The fund is benchmarked against the FTSE ET100 index, which comprises the 100 largest pure-play environmental technology companies, but three-fifths of the portfolio is in mid- and small-caps.
A number of value funds also performed poorly, such as the £284m M&G Global Strategic Value fund and the £196m Ninety One Global Special Situations fund. Value as investment style has not performed well over the last five years and some funds that deviated far from the benchmark in search of value underperformed.