Japan, China and North American smaller companies funds have offered the least correlated returns to the FTSE All Share over five years, according to data from FE Analytics.
Investors may be looking to diversify away from the UK as much as possible at the moment given the result of the Brexit vote and the uncertainty surrounding the region’s outlook.
While the FTSE 100 index has performed strongly since the result was announced, a number of investment professionals still have their reservations as to how the index will behave over the medium to long-term.
Performance of index in 2016
Source: FE Analytics
Simon Smith, chief economist at FxPro, told FE Trustnet last week that the blue chip index’s performance can be attributed to the weakness in sterling as opposed to any strong economic indicators.
Another recent FE Trustnet article reported that Fidelity’s Kevin O’ Nolan has used this market rally to take profits on UK equities, given the slowing global growth forecast and heightened political uncertainty.
“In the aftermath of the referendum we’ve actually seen a relatively strong bounce back with equities to the same levels they were at coming into the referendum,” he said.
“I’ve used that rally to sell into and move to a more aggressive underweight position. I do think this is going to play out over a prolonged period of time and I think ultimately it will impact financial channels.”
For those who want to retain exposure to the UK market while protecting themselves as much as possible, investors may wish to consider pairing their UK funds with those that are particularly lowly-correlated to the FTSE All Share index.
Out of all of the main equity sectors within the Investment Association universe, the IA Japanese Smaller Companies sector bears the lowest correlation over five years at just 0.23 per cent.
Out of the six funds in the sector, Invesco Perpetual Japanese Smaller Companies is the least correlated fund to the FTSE All Share at 0.14 per cent.
It has been headed up by Osamu Tokuno since 2003 and, over one and three years, it has achieved top-quartile total returns. Over the last decade, however, it has underperformed its sector average by 17.57 percentage points with a return of 67.69 per cent.
Performance of fund vs sector and benchmark over 10yrs
Source: FE Analytics
Investors should also bear in mind that the fund might not be for the faint-hearted, given that it is in the bottom quartile for its annualised volatility and in the third quartile for its Sharpe ratio (which measures risk-adjusted performance) and its downside risk (which measures potential to lose money in a bear market) over the last decade.
The top-performing fund in the IA Japanese Smaller Companies sector is Praveen Kumar’s £279m Baillie Gifford Japanese Smaller Companies fund, which is in the top quartile for its total returns over one, three, five and 10 years and has outperformed its average peer by 63.75 percentage points over the last decade with a total return of 144.52 per cent.
The fund, which is benchmarked against the MSCI Japan Small Cap index, has an active share of 93 per cent and is in the top quartile for its Sharpe ratio over the manager’s tenure. However, it is in the bottom quartile for its annualised volatility over the same time frame.
As to be expected, the sector that falls into second place for being the least correlated to the FTSE All Share index is IA Japan, which holds 63 funds and has an average correlation of 0.43 per cent over five years.
The least correlated of these when compared to the FTSE All Share is Legg Mason IF Japan Equity at just 0.06 per cent. The four crown-rated fund was launched by Hideo Shiozumi since 1996 and, over this time frame, it has outperformed its sector average more than nine times over.
Performance of fund vs sector and benchmark
Source: FE Analytics
As can be seen on the above graph though, the fund is incredibly volatile and has been in the bottom quartile for its annualised returns during four of the last 10 years.
The manager aims to exploit structural changes in Japan and does so through selecting stocks with annual earnings growth in excess of 20 per cent and are attractively valued. As such, he often finds opportunities further down the cap spectrum.
For those looking for a lower-octane offering from the IA Japan sector though, Schroder Tokyo is in the top quartile for its annualised volatility and maximum drawdown over three and five years and has a correlation to the FTSE All Share of 0.4 per cent.
It has been headed up by Andrew Rose since 2004 and, over the last decade, it has outperformed its sector average by 28.68 percentage points with a total return of 71.49 per cent. While past performance is of course no guide to future returns, the fund’s short-term returns suggest the fund is better-suited to the patient investor given that it is in the bottom quartile over the last year as well as over three and six months.
The third least-correlated sector to the FTSE All Share is IA China/Greater China, which has a correlation versus the FTSE All Share of 0.69 per cent over five years.
Out of the 36 funds in the sector, NB China Equity has the lowest correlation to the index at 0.51 per cent. The five crown-rated fund is managed by Frank Yao and Lihui Tang and aims to provide growth and income through stocks chosen on both a bottom-up and top-down basis.
It invests in a combination of Chinese A and B shares as well as Hong Kong shares and US ADRs (American Depository Receipts).
The fund has doubled the performance of its sector average over three and five years and is the second highest-performing fund in the sector, but has a higher-than-average annualised volatility over these time frames. That said, it boasts a better-than-average maximum drawdown over three and five years.
Performance of fund vs sector and benchmark over 5yrs
Source: FE Analytics
Another sector that investors may wish to consider as a means of diversifying away from UK equities is North American Smaller Companies, which has a correlation of 0.7 per cent.
The fund with the lowest correlation versus the index over five years is F&C US Smaller Companies, which is £63m in size and is run by Nish Patel.
The fund has a portfolio of 76 stocks, which is reasonably concentrated for a smaller companies fund, and holds companies that are spread over a wide range of sectors.
Over the manager’s tenure, it has returned 41.48 per cent compared to its sector average’s return of 35.66 per cent and in terms of risk metrics, it is in the second quartile for its maximum drawdown, annualised volatility and Sharpe ratio.
Those who are looking to really bolster their returns might want to look at the five crown-rated T. Rowe Price US Smaller Companies Equity fund, which is domiciled in Luxembourg and is $808.6m in size. It has a correlation to the FTSE All Share over five years of 0.69 per cent.
The fund has consistently outperformed both its sector and benchmark over one, three, five and 10 years, returning 235.87 per cent over the last decade compared to its sector average’s return of 179.98 per cent. The fund is also in the top quartile for its Sharpe ratio over the same time frame and is in the second quartile for its maximum drawdown and annualised volatility.
