The average fund in the IA UK All Companies and IA UK Equity Income sectors has produced lower returns with higher volatility than many other parts of the market over the 10 years since the financial crisis started, research by FE Trustnet shows.
This week marked the 10th anniversary of BNP Paribas closing two funds exposed to the US mortgage market because of a “complete evaporation of liquidity”. The months that followed saw conditions worsen, ultimately ending up with the situation now known as the global financial crisis – the effects of which are still being dealt with today.
During the crisis, equities were hit hard as investors fled the riskier parts of the market. FE Analytics shows the FTSE All Share index suffered a maximum drawdown of more than 40 per cent while global equities fell by around 35 per cent.
Performance of stock markets over 10yrs
Source: FE Analytics
However, as the chart above shows, the decade since the crisis has resulted in strong returns as central banks maintained interest rates at record lows and pumped cash into the system through unprecedented quantitative easing programmes.
Although volatility is sitting at low levels today, this hasn’t always been the case and there have been times over the past 10 years when conditions have gotten very rocky indeed.
Therefore, in this article we look at how the market has performed in terms of risk-adjusted returns as indicated by the Sharpe ratio. This commonly used measure calculates the level of a fund’s return over and above the return of a notional risk-free investment, such as cash or government bonds, then divides the difference in returns by the fund’s standard deviation (volatility).
The resulting ratio is an indication of the amount of excess return generated per unit of risk. While there is no absolute definition of a ‘good’ or ‘bad’ Sharpe ratio, beyond the idea that a fund with a negative Sharpe would have been better off investing in risk-free government securities, it is generally considered that the higher the ratio the better.
After looking at all of the Investment Association’s peer groups and ranking them by 10-year Sharpe ratio, it becomes clear that the popular IA UK All Companies and IA UK Equity Income sectors have performed relatively poorly, on average.
As the table below reveals, the best risk-adjusted returns have come from the IA Technology & Telecommunications sector, where the 10-year Sharpe ratio stands at 0.58. The average fund in this peer group has made a 233.79 per cent total return since the start of the financial crisis, with annualised volatility of 15.83 per cent.
Source: FE Analytics
The IA UK Equity Income sector, on the other hand is ranked 22nd out of 38 sectors with an average Sharpe ratio of 0.17 and a 76.64 per cent total return. IA UK All Companies comes in 25th place with a 0.16 Sharpe ratio and 78.68 per cent total return.
However, a number of funds in both UK sectors have delivered risk-adjusted returns much higher than the average and they will be revealed in a follow-up article next week.
In the best performing sector – IA Technology & Telecommunications – the highest Sharpe ratio was posted by Sylvie Sejournet and Nolan Hoffmeyer’s Pictet Digital fund.
The $1.8bn fund has a Sharpe ratio of 0.82 for the 10 years in question. Over the same period it made a 333.57 per cent total return (also the sector’s highest) with annualised volatility of 14.99 per cent.
Performance of fund vs sector and index over 10yrs
Source: FE Analytics
Sejournet and Hoffmeyer’s aim is to build a portfolio that has at least two-thirds of its assets in companies using digital technology to provide interactive services or products associated with interactive services. Its top holding is Amazon, followed by Google parent Alphabet, Tencent, Paypal and Baidu; its largest geographic exposure is to the US (at 57.7 per cent) and China (17.7 per cent).
In their latest update, the managers highlighted that Pictet Digital’s focus on interactive services has aided the fund’s performance: “The fund has benefited from a unique positioning, selecting companies that generate at least 20 per cent of their revenue from interactive applications, with AI [artificial intelligence] being one of the major characteristics.
“The interactive applications group (e-commerce business models, online video games, online advertising, interactive software, FinTech, Big Data analytics tools and healthcare IT) offers secular growth and continues to gain market share. In addition to structural growth, the portfolio is constructed with securities that generate very stable and growing cash flows and have very healthy balance sheets.”
While Pictet Digital has the highest Sharpe ratio in the IA Technology & Telecommunications sector, it is ranked seventh out of the entire Investment Association universe.
TIME Investments Freehold Income comes in first place with a Sharpe ratio of 3.27 per cent. Over the 10 years examined the fund, which invests in freehold ground rents offering a consistent income stream and capital growth, has generated a 105.5 per cent total return with annualised volatility of 1.21 per cent.
It is followed by T. Rowe Price Global High Yield Bond (Sharpe ratio of 0.87), M&G Strategic Corporate Bond (0.87), Morgan Stanley US Advantage (0.83) and Man GLG Corporate Bond (0.83).