It hasn’t paid to take on more risk in the IA UK All Companies sector over the last five years, according to the latest study from FE Trustnet.
While the usual adage is that the higher the risk, the higher the potential reward, FE Trustnet’s research shows lower risk funds have outperformed over the last half decade.
For this study, we used the FE Risk Score metric a measure of volatility relative to the FTSE 100 with 100 being the market’s score. We excluded any with a track record of less than five years.
When dividing the remaining funds in the sector in half, those with lower than average risk scores have on average outperformed those in the higher risk category over the last five years to the end of April.
Performance of high and low risk fund averages over 5yrs to end of April
Source: FE Analytics
The lower-risk half has achieved these returns with lower average volatility and a better Sharpe ratio – a measure of risk-adjusted returns.
Laith Khalaf (pictured), senior analyst at Hargreaves Lansdown, said the FE Risk Score can be viewed as a similar measure to tracking error to the FTSE 100. 
While intuitively mid-caps may be considered more volatile than their large-cap counterparts, over the last five years the FTSE 250 has been less volatile than the FTSE 100, meaning the lower risk score funds may be more mid-cap dominated.
As the FTSE has also outperformed the FTSE 100 by 25.07 percentage points over the period it goes some way to explaining the results as many funds tend to have a mid- and small-cap bias.
However, more recently large-cap funds would have outperformed as the more domestic FTSE 250 stocks suffered in the aftermath of the Brexit vote in 2016.
“Over the period there is one very big event in terms of market movement and that was the EU referendum result which probably helped larger-cap vehicles,” said Khalaf.
“I think it would have helped all the indices to some extent but I think the large-caps were probably the ones to benefit the most.”
Another factor is that UK large- and all-cap passive vehicles, which have no potential to outperform the index net of fees, should have risk scores of nearer 100.
The median risk score in the sector of qualifying funds was 90, meaning that most will appear in the higher-risk bracket.
Laith said that at some point you would expect the winners of the last five years to underperform, and for mean reversion to take place, but it has not as yet.
“We have been in this period where everyone is expecting some kind of reversion in market trends and it has just gone on really,” he said.
“There was obviously the financial crisis and we have had the recovery from that and we are in this long middle period where conditions have remained the same – and that is true in terms of the interest rate environment which has helped certain stocks do better than others – particularly growth stocks instead of cyclical value stocks. That may also play into the data.”
Additionally, in an environment where there is not a great deal of economic growth on the table, people are less willing to take risk, he noted.
This has been compounded by the fact that people have been pushed out of bonds because they have been yielding so little and into the more defensive consumer staple stocks which are less risky, he said, boosting the lower-risk funds.
Khalaf added: “Can that continue? I have no crystal ball but you would expect at some point there will be some sort of reversion in terms of interest rate policy and in value turning the corner versus growth.
“I wouldn’t bet on that being anytime soon though because historically it has been shown that people have expected that to happen and it hasn’t materialised so far.”
As this pattern may or may not continue, below FE Trustnet highlights some of the top performers in both the high and low FE Risk Score buckets.
MFM Bowland is the top fund in the sector over the last five years, returning 131.9 per cent and also happens to have the lowest FE Risk score of 70.
Performance of funds vs sector and benchmark over 5yrs
Source: FE Analytics
The five FE Crown-rated, £16m fund is run by Leon Shuall from Hargreave Hale and aims to provide capital growth through companies spanning the market cap spectrum.
Over the five-year period, it has the best Sharpe ratio in the sector (1.58) with a top quartile volatility figure of 9.41 per cent.
Up next is the five crown-rated, £335m CFP SDL UK Buffettology fund run by FE Alpha Manager Keith Ashworth-Lord.
The fund, which focuses on companies with strong franchises and experienced management teams, has a risk score of 74.
Over the last half-decade the fund has returned 125.54 per cent – the third-best in the sector – with low volatility of 9.11 and a high Sharpe ratio of 1.56.
Other top performing funds with lower than average FE Risk Scores include Slater Growth, Unicorn UK Growth and LF Miton UK Value Opportunities.
For those looking to take on more risk however, there are some top performing high FE Risk Score fund, with two Old Mutual funds also leading the way.
Old Mutual UK Dynamic Equity and Old Mutual UK Mid Cap are the best of the higher risk category, as the below chart shows. They have risk scores of 94, 105 and 101 respectively.
Performance of funds vs sector and index over 5yrs
Source: FE Analytics
While all have produced top quartile returns and Sharpe ratios, they have not been for the faint-hearted, with all three among the most volatile in the sector.
However, there are also funds in both higher and lower camps that have underperformed. In the higher risk category, Scottish Widows UK Select Growth has been the worst performer in the sector, returning 12.69 per cent over the last five years. It has a risk score of 94.
Others of note include M&G Recovery, Sarasin UK Equity and Aberdeen Global UK Equity, which have all produced bottom quartile returns.
At the bottom end of the lower risk group there are also laggards, with HSBC UK Freestyle emerging as the worst performer. It has returned 27.95 per cent over the last three years although does have a top quartile volatility figure of 9.88 per cent.
F&C UK Alpha and GAM UK Diversified are other notable bottom quartile funds in the lower FE Risk Score category.