Investors in global funds experience more downside and less upside than a tracker, according to the latest study by FE Trustnet.
In the final part of its series looking at the upside and downside capture ratios of the Investment Association sectors, we explore the IA Global sector.
Over the 10 years to the end of October, the average IA Global fund has experienced 100.57 per cent of the downside when global equities have fallen, according to data from FE Analytics, while capturing just 87.92 per cent of the upside when markets are rallying.
Upside/downside capture of sector relative to MSCI AC World over 10yrs
Source: FE Analytics
Martin Bamford, managing director at advisory firm Informed Choice, said: “Investors tend to feel downside more than they enjoy upside, so understanding which sectors experience the most downside in falling market conditions is an important part of portfolio construction.”
One of the most significant contributors to underperformance is the lack of exposure to US equities, which have been the strongest performing equity asset class over the last decade.
US companies represent 52.11 per cent of the index while the next largest constituent country is Japan with just 7.86 per cent.
Jason Hollands, managing director at Tilney Investment Management Services, said: “Global equity indices, including the MSCI AC World index, are dominated by the US equities market.
“But the IA Global sector includes a mishmash of products, many of which either aim for a more diversified geographic approach, sometimes including greater exposure to emerging markets than the index will provide, or which structurally have a much larger exposure to the UK because the funds are targeted at domestic investors.”
“The large weighting to the US in global funds is also a clue to performance issues, as we know that the US market has long been a notoriously difficult one for active managers to beat.
He added: “Indeed, the two sectors that have long dominated our Bestinvest Spot the Dog report, have long been littered with both North American and global funds which is no coincidence: beating the US index is very hard.”
Over 10 years to the end of October, the S&P 500 has returned 202.55 per cent while the average fund in the IA North America sector has returned 169.89 per cent, as the below chart shows.
Performance of sector vs index over 10yrs to end of October
Source: FE Analytics
Meanwhile, the IA Global sector has underperformed, returning 95.75 per cent compared to the MSCI AC World’s 124.91 per cent return.
Liontrust head of multi-asset John Husselbee, said: “The sector may be treated in a similar way to US equities where a lot of people are preferring index trackers.
“The US is an efficient market where there are lots of players, lots of research and a lot of the anomalies are arbitraged away. Perhaps global funds should be treated in a similar way.”
Informed Choice’s Bamford added that funds in the IA Global sector tend to be very closely correlated with the MSCI World index, so that explains the downside participation.
“It’s disappointing to see they only manage to capture less than 90 per cent of the upside in times of rising markets.”
He added that this suggests active management is failing where funds are closet trackers, with higher fees leading many to naturally underperform.
“Investors should either move to lower cost index trackers so they can participate in market returns, or alternatively select actively managed funds which don’t hug the index,” the managing director said.
“There are some studies which show funds with a high active share have the potential to outperform the index. If you pay for active fund management, you need to make sure you are getting genuinely active fund management.”
However, Tilney’s Hollands said that buying a global tracker in the current climate could be “a dangerous move” with equity valuations at all-time highs, particularly in the US where the FAANG (Facebook, Apple, Amazon, Netflix and Google) and other tech stocks are exhibiting bubble like characteristics.
“When the balloon eventually deflates, you do not want to be in a fully invested, fully exposed index product,” he said.
“I would therefore opt for managers who are index unconstrained and can buy good companies wherever they can find them, such as Artemis Global Income, Evenlode Global Income, Fundsmith Equity and Lindsell Global Equity.”
It should be noted that the Artemis and Evenlode funds sit in the IA Global Equity Income sector, which has captured 74.01 per cent of the upside of global equities but has also experienced less downside (95.02 per cent).
Upside/downside capture of sector relative to MSCI AC World over 10yrs
Source: FE Analytics
Meanwhile, Fundsmith and Lindsell, the third and fourth best funds in the IA Global sector over the last five years, do not have a long enough track record and are therefore exempt from this study.
The two funds are managed by FE Alpha Managers Terry Smith and Nick Train respectively and have strong quality growth style biases.
Performance of funds vs sector and index over 5yrs
Source: FE Analytics
As such, the funds have been top performers, returning 171.58 and 164.63 per cent over the last half-decade, as the above chart shows – almost double the returns of the sector average.
The five FE Crown-rated, £3.5bn Lindsell Train Global Equity fund has a clean ongoing charges figure (OCF) of 0.75 per cent.
The five crown-rated, £12.9bn Fundsmith Equity has a yield of 0.71 per cent and an OCF of 1.05 per cent.