Old Mutual UK Mid Cap, Fidelity Special Situations and Montanaro UK Income are among some of the funds in the IA UK All Companies sector that have made the best use of volatility over the past decade, according to data from FE Analytics.
The funds, while in the bottom quartile for their annualised volatility over 10 years, are also in the top quartile for their Sortino ratios over the same time frame.
A fund’s Sortino ratio, like its Sharpe ratio, measures risk-adjusted returns over a certain time frame. What sets it apart, however, is that it focuses on downside deviation – in other words, negative deviations from the fund’s minimum acceptable return – and therefore differentiates ‘bad’ volatility from general fluctuations.
Essentially, it is calculated by subtracting a fund’s risk-free rate of return from its actual return over a given time frame; this is then divided by its downside deviation.
For those brave enough, the equation is pictured below:
Source: FE Analytics
Given last year’s violent growth/value rotation and the sheer volume of geopolitical challenges on the horizon, we decided to look at the funds in the IA UK All Companies sector that may, at first glance, have experienced unpalatable levels of volatility for the more cautious investor. But, when looking at their Sortino ratios, have simply captured levels of useful upside volatility while protecting investors’ capital on the downside.
The below table shows the 14 funds in the sector with 10-year track records that have achieved a top-quartile Sharpe ratio while remaining in the bottom quartile for their annualised volatility.
Not only this, all funds on the list are in the top quartile for their total returns over the last 10 years and, with the exception of SVM UK Growth and L&G Alpha Trust, are also in the top quartile for their five-year total returns.
Source: FE Analytics
In the top spot for its Sortino ratio at 0.42 is the five crown-rated Old Mutual UK Mid Cap fund, which has been managed by FE Alpha Manager Richard Watts since 2008.
The £2.3bn fund has a concentrated portfolio of 42 stocks, all of which have been chosen using the firm’s ‘market cycle’ approach. This focuses on the team’s outlook for inflation, economic growth, and interest rates and how this would benefit particular areas of the market at certain points in the cycle. It then looks at companies’ bottom-up fundamentals in terms of their potential to re-rate or achieve earnings upgrades.
The fund is in the top decile for its returns over three, five and 10 years as it has comfortably doubled the performance of its average peer over all of these time frames.
In fact, it has only ever fallen into the second decile for its total return over one year, when it still beat its benchmark by 9 percentage points with a return of 29.79 per cent. It has an annualised volatility of 17.86 per cent over the last decade.
Hot on its heels with a Sortino ratio of 0.4 is Franklin UK Mid Cap, which has been managed by FE Alpha Manager Paul Spencer since 2006 and deputy-managed by Mark Hall and Richard Bullas since 2013.
The fund, which has a 10-year annualised volatility of 17.74 per cent, mostly invests in companies that have markets caps of less than £2bn, although 30 per cent of the portfolio is currently in firms that are between £2bn and £5bn in size.
While the fund has achieved a significant outperformance relative to its benchmark and peer average over the last five and 10 years, it has struggled to do so over shorter timeframes.
Performance of fund vs sector and benchmark over 10yrs
Source: FE Analytics
Over the past 12 months, for example, it is in the bottom quartile for its return of 16.77 per cent compared to the FTSE 250 index’s return of 22.51 per cent and its sector average’s return of 24.27 per cent.
As with Old Mutual UK Mid Cap, it has a highly concentrated portfolio of 36 stocks, with the largest positions – polymer supplier Victrex and heat treatment service provider Bodycote – accounting for 4.26 per cent each of the fund’s AuM.
Other mid-cap funds on the list include Royal London UK Mid-Cap Growth, Barclays UK Lower Cap and Allianz UK Mid Cap.
Standard Life Investments UK Equity Unconstrained, which has a top-quartile Sortino ratio of 0.29, also has a significant weighting in mid-caps at 54.7 per cent. As the name suggests, however, it is able to invest anywhere across the market cap spectrum at any point and is benchmarked against its sector average rather than an index.
The £740m fund is managed by Wesley McCoy, although it was headed up by Ed Legget between 2008 and 2015 after the manager took a break from the company. Investors should be conscious of this when looking at the fund’s performance history, although Legget maintained McCoy’s unconstrained, concentrated and multi-cap approach over his tenure.
Since McCoy has returned to the fund, it has lost 6.07 per cent compared to its sector average’s return of 9.58 per cent. In recent months, however, it has begun to perform broadly in line with its peers.
The research team at Square Mile, which have awarded the fund an ‘A’ rating, said: “Although this fund has the ability to lead to impressive periods of returns the process can be vulnerable at times.
“This is most noticeable when the research output is directing the manager into parts of the market that quickly fall out of favour, such as smaller sized companies or more cyclical firms.”
As such, the fund has the highest annualised volatility out of all funds on the list by at least 5 percentage points at 24.95 per cent.
Another fund on the list that has a distinctly different approach is Montanaro UK Income, which has the same Sortino ratio as SLI UK Equity Unconstrained, but a lower annualised volatility at 17.37 per cent.
It aims to provide attractive and growing dividends for investors, as well as capital growth. Given it was moved to the IA UK All Companies sector for failing to meet the Investment Association’s yield requirements, its benchmark is the IA UK Equity Income sector’s average return.
The £151m fund is in the top quartile for its total returns over three, five and 10 years and has performed broadly in line with its benchmark over the last 12 months.
Performance of fund vs sector and benchmark over 5yrs
Source: FE Analytics
Had an investor placed £10,000 into the fund five years ago, they would have received £2,289.56 in income alone.
There are also a number of value names on the list of UK funds benefitting from upside volatility over the last decade. One such fund is Schroder Recovery, which has been managed by FE Alpha Manager duo Kevin Murphy and Nick Kirrage since 2006.
The £917m fund has a deep value mandate, aiming to find companies that have fallen on hard times and have been underestimated by the market in terms of their ability to recover. The likes of HSBC, Royal Bank of Scotland and Barclays account for some of the fund’s largest individual weightings.
The fund, which has a Sortino ratio of 0.31 and annualised volatility of 18.22 per cent, is in the top decile for its total returns over one, five and 10 years but is in the second quartile over three years for performing broadly in-line with its average peer.
Other top-performing funds capturing the right kinds of volatility over the last 10 years include Cavendish Opportunities, Fidelity Special Situations and Investec UK Alpha.