Investors’ cash has overwhelming flowed to tracker funds for UK equity exposure over the past year, according to research by FE Trustnet.
The three largest recipients of new cash over the past 12 months in the highly-competitive IA UK All Companies sector were are all passive funds; the SSgA UK Equity Tracker, the Vanguard FTSE U.K. All Share Index fund and the BlackRock UK Equity Tracker which collectively took in more than £6bn of inflows.
All three aim to replicate the FTSE All Share index. Collectively the have taken in more than every other fund in the 275-strong IA UK All Companies sector
by a long way.
Source: FE Analytics
However, due to several factors this has meant underperformance of almost half the average fund in the sector.
Performance of funds, sector and index in 2015
Source: FE Analytics
Over six months the numbers are even worse with trackers in the bottom quartile for performance.
Mike Deverell, investment manager at Equilibrium, uses both active and passive UK growth funds to build portfolios and says over the longer term the average active fund is only likely beat a passive fund marginally at best, but that at certain times it can pay to avoid trackers.
“Over the long term we have found that the average UK fund and the FTSE are pretty similar. There is not a lot to choose between them over the really long term. But you do get periods where active does better and passive does better. So, we use both but we do tend to change the weightings depending on what where we think market conditions are at,” he said.
However he says he has scaled back passive exposure over the past year due to worries about certain parts of the market at the larger cap end of the market.
“Recently we have been very light on FTSE trackers partly because we thought there is a lot more value in smaller stocks than large caps - the big mega caps really haven't gone anywhere.”
One of the main reasons for the torrid time for tracker funs of the UK market is broadly bad time for oil and gas and mining which count for about 20 per cent of the broader index.
The graph below illustrated that while the FTSE All Share made a modest gain over one year, the performance of the oil and gas and mining firms has been hugely negative.
The FTSE All Share is up 4.8 per cent the over year, despite the FTSE 350 Mining index being down 37.39 per cent and the FTSE 350 Oil & Gas Producers index 16.78 per cent down.
Performance of indices and sector over 1yr
Source: FE Analytics
In particular, miners have seen weakness due to a material reduced forecast of growth in China – where the most demand for natural resources now comes from, according to Martin Skanberg, European equities fund manager at Schroders.
“Translated profits will be impacted but it is also possible that competitive transactional disadvantages may emerge due to revitalised competition - for example, this could impact some industrial and chemical companies which face strong Chinese competition,” he said.
David Madden, market analyst at IG added: “The wheels are starting to come off in China, and if Beijing is having trouble keeping its stock market in check, it does not inspire confidence in its position as the biggest importer of minerals in the world. London’s relatively high exposure to commodities makes it worse off than its eurozone equivalents.”
Laith Khalaf, senior analyst, Hargreaves Lansdown, says oil and gas has seen a torrid time thanks to the weak oil price as well as lower energy prices leading to weakness for the largest firms.
“Big oil needs to decide whether to keep paying big dividends. Both Shell and BP have prioritised dividends, but the pressure gauge will keep rising if there is further weakness in the oil price. Both companies report in dollars, so while a maintenance of the dividend in cents looks likely, there may yet be a sting in the tail for UK investors,” he said
Passive funds have seen a huge pick-up in demand broadly over the past few years owing to a price war between the biggest passive providers, resulting in very low annual charges.
Also, ultra-low interest rates and easy monetary policy over the past six years have buoying stock markets and thereby decreasing correlation of individual stocks within an index, making trackers perform strongly relative to their actively managed peers.
On top of that, as a consequence or at least alongside this, there has been a gradual move against active management in some quarters with much evidence – mostly referring to the US market – that purports to show few funds outperform over the longer term.
However, an FE Trustnet study recently found this seems less so in the UK equity market where the average active fund in the IA UK All Companies sector had outperformed a basket of trackers over one, three, five and 10 years.
This year was one of the worst over the past year for investors in passive UK equity funds with every tracker fund in the IA UK All Companies sector underperformed the sector average return as well a portfolio of consisting just active funds. The majority of the 25 tracker funds aiming to replicate the FTSE 100 or FTSE All Share were bottom quartile in 2015 with the rest in the third quartile.
