Just 17.25 per cent of active funds in the IA UK All Companies and IA UK Equity Income sectors are outperforming the FTSE All Share in 2016 so far, according to data from FE Analytics, highlighting a huge trend change in the equity market compared to last year. 
Investors will have no doubt noticed that 2015 turned out to be a decent year for the ‘average’ active fund in the UK space, as some of the biggest constituents of the FTSE All Share (such as mining and oil companies) were rocked by macroeconomic headwinds such as China’s growth slowdown and falling commodity prices while, at the same time, more domestically-facing mid-caps benefitted from an improving UK economy.
Therefore, by simply being underweight the top end of the index and taking bigger bets in the lower end of the FTSE 100, the FTSE 250 and small-caps, some 75 per cent of active funds in the two main UK equity sectors managed to beat the FTSE All Share’s gains of 0.98 per cent.
Given that level of outperformance last year, many were expecting active managers to have tougher time of it in 2016. However, though it is still very much early days, the figures so far this year are verging on unprecedented.
According to FE Analytics, just 54 out of a possible 313 active funds in the IA UK All Companies and IA UK Equity Income sectors have managed to beat the index’s losses of 0.3 per cent in the first two and a half months of 2016.
This is further reflected by the fact the ‘average’ active fund has lost 2.47 per cent year-to-date, showing an underperformance of some 200 basis points.
Performance of funds versus index in 2016
Source: FE Analytics
This trend is again highlighted as 86.84 per cent of the IA UK All Companies sector’s passively managed funds have been first or second quartile this year – with the exceptions being portfolios that track less mainstream indices.
The reason for the index’s outperformance is relatively simple, though, as the real ugly ducklings of 2015 – which most managers had little exposure to heading into the year – have come roaring back into favour.
For example, FE data shows that while the FTSE All Share Mining and Oil & Gas indices were again hit hard during the very volatile start to the year as the economic situation in China seemed to deteriorate - commodity prices fell again and geo-political tensions rose. Both have now delivered double digit returns thanks to a 60 per cent gain (in the case of mining) and 30 per cent (in the case of oil) since the end of January as those fears started to dissipate.
Performance of indices in 2016
Source: FE Analytics
On the other hand, the likes of FTSE 250 index, which made 11.17 per cent last year, is still down 2.95 per cent in 2016 thanks to high starting valuations, asset allocation changes among investors and uncertainty over Brexit.
This huge change in market dynamics has had a profound effect on individual fund performances within the relevant Investment Association peer groups as well.
For example, out of the 64 IA UK All Companies funds that are top quartile (and also comfortably outperforming the index) over three years, 89.06 per cent of them are down against the FTSE All Share in 2016. On top of that, some 73.43 per cent are underperforming the sector average and 42.18 per cent currently sit in the bottom sector this year.
It’s a similar story in the IA UK Equity Income sector, with 81.81 per cent of the peer group’s top quartile performers over three years now underperforming the FTSE All Share in 2016. However, only 36.36 per cent of them are bottom quartile year-to-date.
Those include some of the most popular members of the two peer groups.
For example, FE Alpha Manager Mark Barnett’s Invesco Perpetual High Income fund is one portfolio that sits comfortably in the top quartile of the IA UK All Companies sector over three years, but has lost 4.13 per cent this year as areas such as healthcare have posted significant losses during the recent market volatility.
Other top-performing funds that find themselves in the bottom quartile in 2016 include those which have delivered significant market beating returns as a result of their high weightings to mid and small-caps, such as Premier ConBrio Sanford Deland UK Buffettology and Neptune UK Mid Cap as well as the likes of Standard Life Investments UK Equity Income Unconstrained, Ardevora UK Income and Marlborough UK Multi Cap Income in the IA UK Equity Income space.
There are, of course, exceptions to the rule.
These funds that have continued their outperformance in 2016 tend to be those with a high weighting to so-called ‘bond proxies’ like mega-cap consumer staples – which have benefitted from the recent flight to safety in markets and the resultant rally in fixed income yields.
Examples include CF Lindsell Train UK Equity, Trojan Income and Evenlode Income, which are all top quartile over three years and in 2016 have delivered consistent outperformance relative to the wider UK equity market over the medium term.
Performance of funds versus index
Source: FE Analytics
Of course, many anticipated that given active funds had managed to outperform with relative ease, the likelihood that they would go through a period of tougher performance was high.
In fact, the likes of Rory McPherson – head of strategy at Psigma – started allocating to UK trackers at the start of the year to capture the value on offer at the top end of the FTSE 100, arguing that very few active funds were offering exposure to that part of the market.
“What is interesting there is that we have pushed investors out of active funds, which is generally where we like to go, and into passive products because it has been a very easy ride for active managers in the UK as mid-caps have done very well.”
“In the UK, being passive gets you into cheap stuff without paying the fees of an active value manager. In fact, you are seeing value manager drifting into those stocks, so our view is, why pay the fee?” McPherson told FE Trustnet in January 2016.
However, he has now completely liquidated his position in UK passives due to the recent strong gains from the index and some of its largest constituents.
“We’ve actually completely sold our passive allocation. At the start of the year, we thought the valuation disconnection within the market had gone too far. Mid-caps, for example, were very expensive and had been on a fantastic run of performance – and that’s why you had seen such good performance from active funds,” McPherson said.
“However, the valuation difference between mid and mega-caps has now narrowed quite a lot as the likes of energy and mining companies have bounced ridiculously and we think this has now been overdone.”
However, McPherson isn’t recycling those profits into active strategies in the IA UK All Companies or IA UK Equity Income sectors as he is bearish on the outlook for UK equities given growth expectations are been revised down and as there is a lack of monetary support in the domestic market.