Unicorn UK Growth, Slater Growth and Montanaro UK Income are among some of the most volatile UK equity funds generating the strongest and most uncorrelated returns relative to the FTSE All Share over five years, according to research by FE Trustnet.
This comes following an article published yesterday, which looked at the trend of heightened volatility during October and how much of an impact this could have on investors.
Adrian Lowcock, investment director at Architas, said investors need to bear in mind that volatility can be to the upside as well as the downside. In fact, when used in conjunction with other metrics, he said it can provide a good indicator as to how many active bets the manager is making in a bid for alpha.
“Volatility can be up or down,” he explained. “If the managers get it correct, then you get a better return. If you have volatility above the index, then also it shows you that you’re doing something different to the index.”
Simon Evan-Cook (pictured), senior investment manager at Premier Multi-Asset, agreed that more volatile funds are potentially more active than their peers. However, he said investors need to first understand why the fund is volatile before investing. 
"It could be because of a very different market cap focus, or it might be that it only focuses on certain sectors, and completely ignores others,” he said.
“Either way, we need to be comfortable that the volatility is a product of the manager's repeatable, sensible process and not something more concerning.”
With both Lowcock and Evan-Cook’s views in mind, we decided to look at the most actively-managed funds in the IA UK All Companies and IA UK Equity Income sectors over five years which would only be suited to the stronger-stomached investor, and how their portfolios have been structured.
To do so, we filtered through all of the funds with long-enough track records which are in the top quartile relative to the FTSE All Share index for their alpha generation (which measures gains achieved in addition to a benchmark), beta (which measures sensitivity to a benchmark’s movements) and information ratio (which assesses a manager’s use of skill and knowledge to enhance returns).
We also ensured each fund was in the bottom quartile for its r-squared ratio (which measures how closely-correlated a fund is to a benchmark), tracking error (which measures replication of a benchmark’s returns) and annualised volatility.
We discounted all FTSE 250-benchmarked funds as it is not possible to measure their ability to achieve above-benchmark returns relative to the large cap-focused FTSE All Share index.
We were left with a list of six funds which matched our criteria, as shown in the below table.
Source: FE Analytics
Of these, the fund achieving the highest alpha generation over five years at 12.4 (which means that, if the FTSE All Share is presumed to have made nothing over this time frame, it would have achieved gains of 12.4 per cent), is Unicorn UK Growth. It also has the highest annualised volatility at 11.87 per cent.
The £31m fund is headed up by FE Alpha Manager Fraser Mackersie and aims to provide long-term capital appreciation through stocks chosen on a bottom-up basis.
The portfolio has a concentrated number of holdings at 49, which means that each price movement within a portfolio constituent would have a greater contribution to day-to-day volatility. The fund also has a greater focus on small and mid caps relative to its peers, which are areas of the market which can grow or shrink at a quicker pace than larger stocks.
Over five years, the fund has returned 125.91 per cent compared to its average peer and FTSE All Share benchmark’s respective returns of 69.1 and 62.04 per cent.
Investors should note that it has a maximum drawdown (which measures the most money lost if bought and sold at the worst possible times) of 16.35 per cent compared to its benchmark’s drawdown of 11.12 per cent. This is likely to be the result of a tumultuous 2014 when it lost 8.08 per cent, while its average peer and benchmark made small gains.
Next up for its alpha generation of 11.73 is the four FE Crown-rated Slater Growth fund, which has been headed up by FE Alpha Manager Mark Slater since 2005. It has the lowest annualised volatility out of the six funds in our list at 10.7 per cent.
The manager is unafraid to take big bets on companies he has high conviction in. For example, his largest individual weighting - pharmaceutical company Hutchison China - accounts for 10.3 per cent of the overall portfolio. Therefore, the fund is more dependent on the success of one individual stock than many of its peers.
Over five years, the fund has outperformed its average peer and the FTSE All Share (which it is not benchmarked against) by 45.73 and 52.79 percentage points with a total return of 114.83 per cent.
Performance of fund vs sector and index over 5yrs
Source: FE Analytics
As with Unicorn UK Growth, the fund has a bottom-quartile maximum drawdown of 14.32 per cent, although this is likely to be due to losing 2.36 per cent last year while its sector average returned 10.82 per cent.
Investors should note that, in the immediate aftermath of the EU referendum, domestic stocks – of which the fund had considerable exposure to – endured heightened levels of volatility.
Over in the IA UK Equity Income sector, Montanaro UK Income made it into third place with an alpha generation of 8.48. It has the second-lowest annualised volatility of all funds in the list at 10.78 per cent.
The four crown-rated fund, which is managed by Charles Montanaro, resides in the IA UK All Companies sector due to not meeting the requirements to remain in the IA UK Equity Income sector. Nevertheless, it is benchmarked against the IA UK Equity Income sector average.
Again, the fund has a relatively concentrated portfolio at 50 holdings, which could have contributed to its annualised volatility of 10.78 per cent. It also tends to invest in mid- and small-cap companies, which would mean its positioning would differ more from the FTSE All Share and that it could be susceptible to greater volatility.
Over five years, the fund has returned 107.78 per cent compared to its average peer and benchmark’s respective returns of 69.1 and 67.01 per cent.
Performance of fund vs sector and benchmark over 5yrs
Source: FE Analytics
As with Slater Growth, the fund endured a difficult year last year when it returned just 0.97 per cent. Again, investors should note that the fund has more of a domestic-facing bias than many of its peers, which may have contributed to turbulence.
Other funds to have made the list include L&G UK Special Situations Trust, Premier Ethical, and EdenTree UK Equity Growth. In terms of the latter two funds, their ethical mandates lead to certain stock and sector restrictions, which may have caused their differentiation in comparison to the FTSE All Share.