Active UK equity managers struggled to outperform the benchmark during 2017 although small-cap strategies emerged as the best performers, according to data from S&P Dow Jones Indices.
The latest biannual S&P Indices Versus Active Funds (SPIVA) Europe Scorecard found that just 53.6 per cent of active UK equity managers outperformed the S&P United Kingdom BMI benchmark last year.
This represented a big fall from the previous SPIVA Europe Scorecard for the year to 30 June 2017 when around 80 per cent of active managers beat the benchmark over one year.
The best performing segment was UK Small Cap Equity, where 80.3 per cent of funds outperformed the S&P United Kingdom SmallCap index, although this too was down from 93.75 per cent for the previous Scorecard.
However, less than half of UK Large/Mid Cap Equity funds outperformed the S&P United Kingdom LargeMidCap index over one year.
Andrew Innes, associate director for research and design at S&P Dow Jones Indices, said: “In the sterling-denominated funds category, 61 per cent did outperform but it doesn’t mean all funds outperformed. There’s still a significant proportion underperforming the benchmark.”
He noted: “If we were to try to explain why they outperformed in 2017, the year itself was one of very low volatility, a risk-on environment.
“Small-cap stocks have done particularly well, so we’ve seen many markets where the average stock return has beat the benchmark meaning smaller companies have tended to outperform.
“Therefore, fund managers who have weights that were more diversified or less exposed to larger companies could have found it relatively easier to outperform under those conditions.”
Performance of UK equity fund sectors vs FTSE All Share in 2017
Source: FE Analytics
Innes said fluctuations over the short term were common and that longer-term figures were more meaningful, with three-quarters of funds underperforming the benchmark over the longer time frame.
Indeed, 75.19 per cent of UK equity funds underperformed the benchmark. This was marginally lower for UK small-cap equity strategies where just 27.1 per cent outperformed the relevant benchmark.
The latest Scorecard also showed that sterling-denominated funds investing solely in US equities provided average returns that were below the local currency-adjusted S&P 500 benchmark over all time periods analysed. Sterling funds investing in emerging markets also failed to outperform. 
Innes (pictured) said: “We do notice not just in sterling-denominated but in lots of euro-denominated funds a lot of the categories that are exposed to international stocks typically are among the region’s worst performers.
“It’s not a new trend. We’ve seen that pattern for many years and I guess that one possible explanation that it is a local advantage for picking stocks.
“So, if you’re a local investor where you’re picking the stocks you have some advantage there.”
Around two-thirds of sterling-denominated funds underperformed the S&P 500 (in sterling terms) over one year with that figure rising to 93.4 per cent over 10 years.
Performance of IA North America sector vs S&P 500 in 2017
Source: FE Analytics
Similarly, 62.4 per cent of sterling-denominated funds investing in emerging markets failed to outperform the S&P IFCI index over one year, with this figure rising to 84.85 per cent over the past decade.
“For emerging markets, we highlighted that figure as being one of the worst categories because it’s of interest to those that believe it’s easier to outperform in less efficient markets: our figures don’t support that view,” said S&P Dow Jones Indices’ Innes.
Sterling-denominated funds investing in global equities fared a bit better with 47.3 per cent outperforming the S&P Global 1200 index, although that figure falls to just 5.1 per cent over 10 years.
Elsewhere sterling-denominated European equity funds had mixed performance. More than 60 per cent of pan-European funds beat the benchmark last year, however, less than half of Europe ex-UK equity strategies outperformed its benchmark.
Over 10 years, just 24.2 per cent of Europe including UK funds beat the S&P Europe 350 index with that figure increasing to 26.5 per cent for Europe ex-UK strategies beating the S&P Europe ex-UK BMI index.
Innes said there had been some impact from currency movements last year, but that those hedging risk would have been protected to some extent.
“With regards to currency, the most interesting story of the year was how much the dollar depreciated and how it affected returns for local investors in the UK exposed to international markets,” he explained.
“It would have dampened those returns. So, any investor in the UK who decided to hedge the currency risk US dollars would have done particularly well.”
With markets having exhibited low volatility through much of 2017, concerns over higher inflation and the potential for faster rate hiking by the US Federal Reserve has seen greater levels of volatility during the first quarter of 2018.
“With regards to the lower volatility environment one argument is that there would be typically low dispersion stock returns and there would be less opportunity for active managers to outperform,” said Innes.
“But what we’ve seen, particularly in the UK, is that the low volatility environment is a big risk-on environment.
“We saw a lot of small size companies tend to outperform. A random selection of stocks in the UK with random weights would on average typically beat the benchmark return.”
Performance of VIX over 1yr
Source: CBOE
He added: “We conclude fund managers less exposed to those larger companies could have done particularly well and that’s one explanation for the numbers we’ve seen in 2017 in the UK.
“Should that low volatility environment change in 2018 now a matter of whether fund managers are well-positioned to take advantage of that.”
Considering longer-term performance figures, Innes said the impact of the global financial crisis is still being seen within returns, but that they often reveal a similar story.
“Those funds that went through [the financial] crisis will have been in the SPIVA figures for quite some time now and still just included in last yearly report,” Innes said.
“Our argument would be that it is fair to include the downturns because it does paint a more accurate picture of a full market cycle.
“If you wanted to see the effect without that included in the financial crisis equally you can look at the five-year numbers and across many of our categories you will see they tell a similar story to our 10-year numbers anyway.”