Advisers and analysts often use volatility and the Sharpe ratio to measure risk and risk-adjusted returns on a fund, but these tell you how a fund performs in all markets, not just when it is under pressure.
Downside risk isolates the "downward" volatility of the fund and the Sortino ratio looks at risk-adjusted performance when the fund loses money.
These measures more realistically capture what the average retail investor understands as "risk", which is more to do with the amount of money they might lose, rather than the dispersion of returns around a mean.
Data from FE Analytics shows that there are some funds that perform especially well on the downside, which might make them appeal to more cautious investors.
Aberdeen UK Smaller Companies stands out as one such fund.
Aberdeen as a house is known for having a cautious, safety-first approach, looking for long-term investments rather than short-term ways to make a lot of cash.
It has had the most success with this in the emerging markets sector, but its UK smaller companies fund displays similar characteristics.
The fund has the fourth-lowest downside risk in the sector over the past three years, but just the 11th-lowest volatility.
Its Sortino score of 1.02 ranks 20th, whereas its Sharpe ratio of 1.1 ranks it just 23rd.
Investors may have to sacrifice some potential for returns if they pick this fund, however. Our data shows that the £184m portfolio has marginally underperformed the average fund in the sector and the FTSE Small Cap index over three years.
Aberdeen UK Smaller Companies has made 60.4 per cent compared with 60.97 per cent from the sector and 63.02 per cent from the FTSE Small Cap ex IT index.
Performance of fund vs sector and benchmark over 3yrs
Source: FE Analytics
However, our figures suggest that when the market eventually starts to pull back, this fund will protect its gains better than the vast majority of its peers.
Discretionary Trust is another to display particularly strong performance on the downside.
The fund is 11th in the sector in terms of downside risk over three years, with a figure of 13.87 per cent. However, it is just 16th in terms of volatility, with 12.86 per cent.
This means it beats more of its peers in down-markets than it does in up-markets.
The fund has been managed by Simon Knott since 1990, and our figures suggest he excels when the fund is under pressure.
He has the fifth-highest Sortino over the last three years but just the 11th-highest Sharpe, suggesting he adds most of his value in poor markets.
Despite this low-risk style, he has made top-quartile returns over the last three years, with the £30m fund returning 80.46 per cent, according to data from FE Analytics.
Performance of fund vs sector and benchmark over 3yrs
Source: FE Analytics
Simon Knott is also an international chess master.
Other funds that stand out on this measure are CF Progressive UK Smaller Companies, which is 167th for downside risk and 27th for volatility, and TB Amati UK Smaller Companies, 19th for downside risk and 25th for volatility.
Our data shows that nine of the top-10 funds in terms of volatility are also top-10 in terms of downside risk, but that beyond that there are many significant differences in the rankings, suggesting that investors would do well to consider both measures.
Downside risk and volatility of smaller companies funds over 3yrs
| Name | Volatility | Rank | Downside Risk | Rank |
|---|---|---|---|---|
| Artemis UK Smaller Companies | 9.07 | 1 | 11.03 | 1 |
| Liontrust UK Smaller Companies | 10.79 | 3 | 12.07 | 2 |
| MFM Techinvest Special Situations | 10.77 | 2 | 12.47 | 3 |
| Aberdeen UK Smaller Companies | 12.19 | 11 | 13.09 | 4 |
| HSBC UK Smaller Companies | 10.8 | 5 | 13.21 | 5 |
| Unicorn UK Smaller Companies |
11.43 | 8 | 13.3 | 6 |
| Schroder UK Smaller Companies | 10.87 | 6 | 13.36 | 7 |
| Aviva Inv UK Smaller Companies | 11.6 | 9 | 13.57 | 8 |
| Cavendish AIM | 11.24 | 7 | 13.59 | 9 |
| Henderson UK & Irish Smaller Companies | 10.79 | 4 | 13.8 | 10 |
| Discretionary | 12.86 | 16 | 13.87 | 11 |
| S&W - Wood Street Microcap Investment | 11.99 | 10 | 14.13 | 12 |
| Stan Life Inv UK Smaller Companies | 13.6 | 23 | 14.51 | 13 |
| Investec UK Smaller Companies | 12.88 | 17 | 14.73 | 14 |
| AXA Framlington UK Smaller Cos | 12.41 | 12 | 15 | 15 |
| Jupiter UK Smaller Companies | 12.86 | 15 | 15.1 | 16 |
| CF Progressive UK Smaller Companies | 13.7 | 27 | 15.13 | 17 |
| Invesco Perp UK Smaller Companies Equity |
13.59 | 22 | 15.28 | 18 |
| TB Amati UK Smaller Companies | 13.68 | 25 | 15.51 | 19 |
| Newton UK Smaller Companies | 13.7 | 26 | 15.54 | 20 |
Source: FE Analytics
Our figures show that there tends to be less difference between the Sharpe and Sortino scores of funds in the sector.
Baillie Gifford British Smaller Companies is ninth in terms of Sortino and 13th in terms of Sharpe.
The £208m fund, which has been managed by Douglas Brodie since November 2007, is a perennial top-quartile performer, and ranks fourth in the sector over three years, with returns of 89.35 per cent.
Performance of fund vs sector and benchmark over 3yrs
Source: FE Analytics
FE Alpha Manager Harry Nimmo’s £1.1bn Stan Life Inv UK Smaller Companies fund is another to have better risk-adjusted returns on the downside: the fund is 11th in terms of Sortino and 16th in terms of Sharpe.
This disparity may be due to Nimmo holding larger companies in his fund which were much smaller when he bought into them – "running his winners" – which could limit relative gains in bull markets for smaller companies.
As well as the Aberdeen and Discretionary funds already mentioned in this piece, Henderson UK & Irish Smaller Companies and Aviva Inv UK Smaller Companies score marginally higher in terms of Sortino and Sharpe.
Liontrust UK Smaller Companies also has a marginally better record on the downside.
Of course, a high-risk fund can score highly on Sharpe or Sortino, which means that the measures need to be read in conjunction with the volatility and downside risk calculations if you are picking a low-risk fund.
Funds that principally invest in the AIM market were excluded from this study.
