Liontrust UK Smaller Companies, Stewart Investors Asia Pacific Sustainability and Jupiter European are among the top funds for alpha generation in the best sectors, according to FE Analytics. 
In previous studies, FE Trustnet found that, on average, funds in the IA UK Smaller Companies, Europe ex UK and Asia Pacific ex Japan were able to generate alpha against their relevant benchmarks over the past decade.
Thesis Asset Management model portfolio manager Gaurav Gupta says the data highlights the challenge faced by fund selectors when it comes to picking active managers who can outperform their benchmarks and, in addition, rank highly versus their peers.
Below, we look at why these sectors have outperformed on average and examine some of the individual funds that have generated the highest level of alpha against their own respective benchmarks.
One thing UK smaller companies and Asian equities have in common is the fact that both are under-researched by global investment banks, according to Jason Hollands (pictured) managing director at Tilney.
“Both are market segments that are under researched by investment banks and stockbrokers and this creates opportunities for fund managers to ‘discover’ hidden gems that the market has overlooked,” he said.
“It’s much harder for a fund manager to genuinely spot something the market hasn’t when they’re investing a highly liquid market like US large caps, where stocks are poured over by armies of fund managers, hedge funds and analysts and where the companies themselves employ investor relations teams to guide the market.
“As investment banks got bigger, absorbing smaller local broking firms, their research coverage has increasingly narrowed to cover larger firms which might have appeal for an international client base and of course in recent years, as investment banks have had to unbundle the cost of research from trading commissions, research functions have shrunk significantly as this is no longer as lucrative.”
Performance of sector and benchmark over 10yrs
Source: FE Analytics
The IA Asia Pacific ex Japan sector has underperformed the MSCI AC Asia ex Japan index by 6.97 percentage points over the last decade, despite having a positive alpha generation score of 0.42.
The best fund in the sector for alpha generation is Stewart Investors Asia Pacific Sustainability, run by FE Alpha Manager David Gait and Sashi Reddy.
The £396m, five crown-rated fund, which has returned 289.58 per cent over the last 10 years with an alpha score of 7.58, is underweight financials and overweight healthcare compared to the benchmark.
The lowest alpha generator is the £58.2m F&C Pacific Growth fund, managed by Ben Akrigg, which has a score of -3.72.
Other notable high alpha generators in the IA Asia Pacific ex Japan sector include Stewart Investors Asia Pacific (6.24) Aberdeen Global Asian Smaller Companies (5.14) and Schroder Asian Income (4.18).
Turning to IA UK Smaller Companies, a lack of research is not the only reason active managers have tended to fare better, according to Tilney’s Hollands.
“Alongside this, the growth of passive investing has also left smaller companies ignored,” he said.
“Take the UK, where the FTSE All Share Index notionally includes 636 companies of which 284 are smaller companies (about 45 per cent).
“Yet as a result of weighting holdings based on their market capitalisation, an investor in a FTSE All Share tracker will end up with 35 per cent of their investment in the 10 largest companies and the amount they have in these 284 smaller companies will get zapped down to a nearly meaningless 3.3 per cent of the fund.
“And of course none of this even touches the 982 smaller companies on AIM. My point is that as more money has migrated to index strategies, smaller companies get ignored and therefore the opportunity set for small-cap managers who do some homework just gets better.
“In many ways the onward march of passive investing will be the salvation of active management as the more cash that follows big stocks like lemmings, creates more opportunities for genuine stock pickers to outperform.”
On average, the IA UK Smaller Companies sector has an alpha generation score of 0.49 over the last decade and the top fund for alpha is the Liontrust UK Smaller Companies, which is significantly higher at 6.71.
The £598m, five crown-rated fund is run by FE Alpha Managers Anthony Cross and Julian Fosh as well as Victoria Stevens and Matthew Tonge.
Performance of fund vs sector and benchmark over 10yrs
Source: FE Analytics
The fund has returned 228.08 per cent over the last decade while the Numis Smaller Companies ex IT index has produced 116.30 per cent.
Liontrust UK Smaller Companies is particularly overweight the technology sector while underweight industrials and financials.
Conversely, the £168m Henderson UK & Irish Smaller Companies fund run by Rob Giles and Adam McConkey is the lowest alpha generator in the sector (-3.22).
Other notable high alpha generators in the IA UK Smaller Companies sector include Marlborough UK Micro Cap Growth (5.86), Old Mutual UK Smaller Companies Focus (5.21) and Schroder UK Dynamic Smaller Companies (4.60).
The third area to outperform – Europe – is differs from the other two as it is well researched, according to Hollands.
“Europe is a slightly different situation. Here the banks represent a big slug of the index but many active managers have avoided European banks since the credit crisis as the Eurozone debt crisis has rumbled,” he said.
“European banks have never really done the extent of recapitalisations we saw in the US or UK. Avoiding European banks for years has been a good call and a ticket to outperformance.”
The IA Europe ex UK sector, on average, was the highest alpha generating sector (0.94) when compared against the MSCI Europe ex UK.
The top offering for alpha generation over the last decade is the £86m Stonehage Fleming European All Cap Equity fund, run by FE Alpha Manager Robrecht Wouters and boasting a 7.05 alpha score.
Another fund Thesis’ Gupta points to is JPM Europe Dynamic ex UK, which he uses for exposure to Europe.
“We currently invest into JPM Europe Dynamic, which has an active manager who aims to generate alpha by investing into stocks that exhibit certain characteristics,” he said.
“Typically the fund invests in companies that are profitable, attractively valued, fundamentally sound and supported by the market.
“These securities have better traits than the market and therefore the overall portfolio should outperform consistently.”
The fund has a positive alpha generating score (1.82) narrowly missing out on being in the top quartile over the last 10 years, but has been a top quartile performer for total returns, producing 103.46 per cent over the last decade.
Performance of fund vs sector and benchmark over 10yrs
Source: FE Analytics
“Performance over the last 10 years has been strong and the fund has outperformed the benchmark by a significant margin,” the portfolio manager said.
“The last five calendar years have been exceptionally strong, as it has beaten the benchmark four out of five years demonstrating consistency. Last year it marginally underperformed the benchmark but still ranked highly versus peers.”
The lowest alpha generating fund in the sector is HSBC GIF Euroland Equity (-2.34) though this is relatively high compared to other sectors’ worst performers.
Other notable top alpha generators include Jupiter European (5.81), BlackRock European Dynamic (5.21) and Man GLG Continental European Growth (4.58).