Last year proved to be a good one for active UK fund managers but investors need to be wary of reading too much into the data, according to several market commentators.
In 2017, the IA UK All Companies sector outperformed the FTSE All Share benchmark by 89 basis points with the average fund in the sector producing alpha – a measure of a funds over or underperformance relative to a benchmark – of 4.41.
While the average fund in the IA UK Equity Income sector produced alpha above the benchmark of 2.69 however, the sector actually underperformed the benchmark by 1.78 percentage points, as the below chart shows.
Performance of sectors vs benchmark in 2017
Source: FE Analytics
Ryan Hughes, head of fund selection at AJ Bell Investment Management, said: “2017 was a better year for active managers, particularly in the IA UK All Companies sector with the sector average managing to outperform the FTSE All Share index over the year.”
Overall, 41 per cent of funds outperformed the FTSE All Share last year – though there are a number of passive vehicles in the IA UK All Companies sector that by definition should underperform.
In total, 22 per cent of funds in the IA UK Equity Income sector beat the index while 47 per cent of the IA UK All Companies sector outperformed.
While these figures may not be as unanimous as some may have expected, they are significantly better than the previous year, when just 15 per cent of funds from across the two sectors beat the benchmark.
“Given how poor 2016 was, it is heartening to see that some managers managed to find opportunities to outperform the market and this performance has fed through into the longer-term alpha numbers,” Hughes said.
Indeed, over a 10-year period the IA UK Equity Income and IA UK All Companies sectors have on average provided alpha of 0.98 and 0.48 respectively.
This is an improvement on last year when FE Trustnet ran a similar study, which showed over the decade to the end of 2016 the IA UK All Companies had failed to generate alpha on average (-0.12) while the IA UK Equity Income sector had an alpha score of 0.11.
As the below chart shows, the 10-year alpha score rose steadily throughout last year as each positive month in 2017 also knocked off a month from 2007 – a more challenging time for active managers with just 22 per cent of funds beating the index over the calendar year.
Rolling 10-yr alpha generation of sectors vs index over 2017
Source: FE Analytics
With such discrepancies, it is fair to wonder whether even taking a 10-year view is a long enough track record, as the figures can be swayed by one good or poor year.
Rob Morgan, pension and investment analyst at Charles Stanley Direct, said: “I think 10 years is fair to compare ‘over the cycle’.
“What’s interesting is that dropping 2007 – a relatively poor year for small- and mid-cap – and adding 2017 – a relatively good one for these stocks – has made a significant difference to the alpha of UK equity funds. This is down to the small- and mid-cap bias of active funds.
“In fact, you might argue this is not actually real alpha but style-related under- and outperformance, and in some instances I believe that is the case.”
When looking at a measurement such as alpha, AJ Bell’s Hughes said the devil is in the detail as the ‘average’ alpha of the sector masks the fact that the majority of managers underperform over the long term and the average is skewed by some very high alpha generators.
“These very strong performers have been able to drag the sector average upwards so that over five and 10 years, the average beats the All Share,” he said.
Indeed, on a rolling 10-year basis, the top 10 per cent of funds across the two UK sectors have on average produced significantly higher alpha (5.87) relative to the index.
Rolling 10-yr alpha generation of portfolio vs index over 2017
Source: FE Analytics
“The challenge for myself and my fellow fund selectors is to find those managers who have the ability to deliver consistent alpha,” Hughes explained.
While they are rare, he said they do exist and noted that if markets become more volatile, as many commentators expect, it may well create a level of dispersion in the market that helps active managers claw back some ground against their passive counterparts.
Martin Bamford, managing director at Informed Choice, said however that investors should not see active and passive funds as opposites to one another.
“Many are too dismissive of active fund management and it certainly has its flaws, with too many actively managed funds acting as closet trackers and charging way over the odds for the value they provide,” he said.
“Index-tracker funds offer a great way to get broad exposure to asset classes at low cost, but might not be best suited in every scenario.”
Bamford added: “Our own preference is for a blend of active funds and index trackers within a portfolio, using the right tools for the right jobs.”
In an upcoming article FE Trustnet will look at the highest alpha-generating funds in the two UK sectors over the last decade.