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The charts showing why your active fund has struggled in 2016

01 November 2016

Frequent rotation between market leaders means that many active funds have struggled to make any meaningful gains this year.

By Gary Jackson,

Editor, FE Trustnet

It has been noted on a number of occasions how difficult a year 2016 has been for active managers, with the average fund struggling to keep pace with their benchmarks in a number of sectors.

FE Analytics shows that the average fund in both IA UK All Companies and IA UK Equity Income sectors has made around half the total return of the FTSE All Share since the start of the year.

To put this into some kind of context, the IA UK Equity Income sector has beaten the FTSE All Share in each of the previous six full calendar years while the IA UK All Companies sector is ahead of the index in five of the past seven.

Performance of sectors vs index over 2016

 

Source: FE Analytics

This is by no means a UK-only issue. The average IA Global fund is behind the MSCI World over 2016 so far while the IA Europe ex UK sector’s average member has failed to keep pace with MSCI Europe ex UK index, for example.

Simon Evan-Cook, senior investment manager in Premier’s multi-asset team, said: “It’s been a topsy-turvy year, to say the least. There hasn’t been a single theme behind markets’ movements that explain them all away. What’s worked in one quarter has then viciously reversed the next.

“If you’d been trying to call it on a month-by-month basis - which thankfully we don’t - it must have been an absolute nightmare to navigate. For it’s in these conditions that the risk of being serially whipsawed is at its highest, and there’s no quicker way to exhaust your investors’ patience.”

However, Evan-Cook says there is one underlying driver of market movements that seems to make sense: investors “seesawing” between having a deflationary outlook and a reflationary one.


“Investors’ collective mood is dictated by what they think their future will hold,” he said.

“For the last few years, they have been increasingly convinced we are headed for permanent deflation. So hopes of inflation (or, for some, fears of hyperinflation), have given way to the belief that growth is scarce, and that spending and consumption will stagnate or shrink.

“There are, however, some signs that the deflationary pendulum has reached the end of its swing and may be about to swoop back in the other direction. Or, at the very least, there are signs that investors are beginning to expect it to. The ‘other direction’, at least to begin with, means ‘reflation’. This is when factors like rising spending, consumption and credit growth force a spiral of rising prices.

“As soon as the weight of expectation begins to switch from one to the other, volatility picks up, and market leadership changes.”

On an asset level, investors tend to favour ‘growth’ equities during times they fear deflation while ‘value’ becomes more attractive for a reflationary environment. The chart below shows how market leadership has swung violently between these two styles over the past 12 months.

Monthly performance of UK growth vs value over 1yr

 

Source: FE Analytics

“This matters, because if you’re buying an asset or a fund that has done well over the last few years, chances are it’s a ‘deflationary winner’. Likewise, if you’re selling because a fund or an asset has performed poorly over the same period, there’s a fair chance it’s a ‘reflationary winner’,” Evan-Cook said.

“And if the trend has reversed, that could mean several long years sat in an underperforming investment. If that sounds like Sod’s Law waiting to happen, then take note, it may be just that.”

The manager recently told FE Trustnet that he is holding funds for both outcomes as investing on the back of a macroeconomic view is often a difficult task.


The UK has been particularly affected by this change in market leadership.

UK growth assets were in favour when the political mantra was all about austerity as this was seen by investors as deflationary. However, the move towards increased infrastructure spending and a higher minimum wage prompted more attention on value or cyclical equites.

But the rotation between growth and value has been seen at a global level as well over the past 12 months, as the following chart illustrates.

Monthly performance of global growth vs value over 1yr

 

Source: FE Analytics

Given that this dynamic has been so unpredictable in recent months, the Premier multi-asset team is unwilling to back one or the other, pointing out that it will take time until the long-term winners and losers are determined.

“Since the financial crisis, deflationary assets (aka ‘growth’) have been in the ascendancy over reflationary assets (aka ‘value’), for all but a brief hiatus after the euro crisis in 2012,” Evan-Cook said.

“But in 2016, the trend has flattened, flipping between the two regularly as the world decides whether the winds are about to change, or carry on as before.

“As far as we’re concerned, the ‘best of both’ strategy is the safest path through potentially treacherous grounds. This means we’ll lag a few of the more ‘heroic’ funds out there: those who don’t mind betting their investors’ savings on one outcome or the other. But for every heroic winner that got it right, there’ll be many more that either got it straight-up wrong or got it right but lost faith along the way.”

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.