In this series of reports, we are aiming to highlight funds from each of the IMA sectors that fit certain criteria. In picking those criteria, we want to take a more rounded view of fund selection, and challenge the idea that the investment to go for is simply the one that generates the biggest headline return.
We shall be using the terms ‘top’, ‘bottom’, ‘best’ and ‘worst’. These words should not be taken to mean that there is anything intrinsically good or bad about the funds about which we use such terms; they are meant to describe how well or otherwise they fit the criteria we have selected. Where there is an evident reason for the degree of fit, we shall point it up in the text.
Methodology
The methodology used to determine the ‘Top’ and ‘Bottom’ funds will differ for each sector, depending on the predominant aim of the sector. For example, the volatility element would be of much greater significance when looking at the IMA Cautious Managed sector than when looking at Global Emerging Markets.
The criteria used for the determining the ‘Top’ and ‘Bottom’ funds in the IMA UK All Companies sector are:
· Crown Ratings (Crown Ratings are assigned after measuring three factors: performance, volatility and consistency. The highest rating is three crowns)
· Performance over 36 months
· Information Ratio
· Sharpe Ratio
· Quartile over both 1 year and 3 years
· Volatility
Using these criteria it is possible to get a preliminary list of the best and worst funds in the sector. This first list, usually containing about 10 funds, is analysed to reach the final five. We can now turn to the first of our tables and the analytical commentary.
Table 1: Top 5 funds (3 years to 2nd July 2007)
| citicode | First Price | Crown rating | Quartile over 1 year | Quartile over 3 years | 36 month bid-bid performance | Info ratio vs sector | Sharpe | Ann. Volatility | TER | |
|---|---|---|---|---|---|---|---|---|---|---|
| BlackRock ML Mgrs UK Special Situations | ME21 | Jan-95 | 1 | 1 | 91.77 | 1.96 | 2.27 | 9.08 | 1.59 | |
| Jupiter UT Mgrs Environmental Income | JU21 | Nov-99 | 1 | 1 | 88.71 | 1.22 | 2.29 | 8.74 | 1.77 | |
| Rensburg Fund Mgmt UK Select Growth Trust | BE01 | Oct-01 | 1 | 1 | 82.88 | 1.73 | 2.21 | 8.43 | 1.57 | |
| Old Mutual Fund Managers UK Select Mid Cap | BF01 | Feb-02 | 1 | 1 | 112.72 | 1.79 | 2.09 | 11.91 | 1.54 | |
| Rensburg Fund Mgmt UK Mid Cap Growth Trust | BE29 | Sep-99 | 1 | 1 | 109.24 | 1.51 | 2.05 | 11.83 | 1.53 |
Analytical commentary
Since this sector is so diverse, potential investors and their advisers would do well to formulate a clear sense of what risk/reward characteristics they are looking for. In the analytical detail we can find quantitative guidelines that help this process.
What’s striking here is that higher cost – in terms of Total Expense Ratio and riskiness – is not progressive as one moves up the performance ladder. As we shall see, Manek’s Growth fund carries the highest TER, and the second-highest level of volatility, yet features in the bottom 5 funds performance-wise.
So, arguably, this is not a sector where those factors should be predominant in making a selection: we should be looking for the stockpicking talent first, and assessing the associated costs second.
Sharpe can indicate in broad terms which funds are staying ahead of risk-free investments, and still making a return for each unit of volatility that the investor is taking on. However, since the field is so large and heterogeneous, we could benefit from a measure that more precisely identifies fund managers who have added value for investors by making bets away from the benchmark. To this end, Information Ratio (IR) provides the acid test, and this will figure a little later.
In our top group, the headline-grabber is Old Mutual’s return of 112.72% over three years. But, if we want to consider the risk factor in this result, Sharpe tells a different story. In fact, BlackRock’s fund outperforms, by generating 2.27% for each unit of volatility taken on, against 2.09% from Old Mutual’s offering. In fact, we can also find superior Sharpe in the Rensburg UK Select Growth and Jupiter funds. The lowest Sharpe in this group, from Rensburg’s mid-cap offering, reflects the rôle of volatility in the Sharpe measure, and puts the fund’s second-highest return into context.
Sharpe does not distinguish between returns generated by the manager’s skill and those that would have come anyway from benchmark movements. Information Ratio does: its basis is the excess return after the deduction of both a nominal risk-free rate and the benchmark return. The excess return is then divided by its own volatility (the Tracking Error), and can tell us how much gain the manager is making for each unit of risk in those non-benchmark bets. While an IR of 1.0 is considered a very good performance, and Old Mutual is no slouch here, BlackRock’s superb 1.96 means that its fund scores again. That said, the Jupiter and Rensburg funds can claim exceptional performances on this measure.
And now for those funds that least fit our criteria.
Table 2: Bottom 5 funds (3 years to 2nd July 2007)
| citi code | First Price | Crown rating | Quartile over 1 year | Quartile over 3 years | 36 month bid-bid performance | Info ratio vs sector | Sharpe | Ann Volatility | TER | |
|---|---|---|---|---|---|---|---|---|---|---|
| Marlborough Fund Mgrs UK Equity Growth | QM18 | Jan-95 | 4 | 4 | 27.09 | -0.81 | 0.39 | 12.3 | 1.63 | |
| New Star Inv Funds Select Opportunities | NH26 | Jun-02 | 4 | 4 | 28.28 | -1.15 | 0.44 | 11.27 | 1.79 | |
| Fidelity Investments UK Growth | FI83 | Jan-95 | 4 | 4 | 48.21 | -0.89 | 1.05 | 9.95 | 1.7 | |
| Manek Inv Mgmt Growth | MK02 | Dec-97 | 4 | 4 | 48.71 | -0.41 | 0.86 | 12.1 | 2.06 | |
| Soc Generale Inv Funds UK Concentrated Core | YY87 | Sep-99 | 4 | 4 | 51.9 | -0.73 | 1.15 | 9.8 | N/A |
At the other end of the scale, investors in Marlborough’s fund would be entitled to feel disappointed by such a low return from a sector that offers rich pickings for the active manager. With a Sharpe of 0.39, the fund barely provides a return per unit of volatility that it takes on, and its Total Expense Ratio is higher than that of most of the top funds, too. But this is where we need to be careful. In common with Manek’s fund, it bears little or no correlation to the sector in which it finds itself, and some quantitative comparisons with its peers are unreliable at best. A search for a more appropriate sector reveals no stronger correlations, and investors would probably do better to view these two funds in terms of absolute return funds.
A similar lack of correlation is manifest in the New Star fund. The search for a more suitable benchmark points us towards IMA’s UK Smaller Companies, where the r-squared measure of correlation is a relatively robust 0.83. In this environment, the fund fares worse, with the benchmark-adjusted Information Ratio slipping from -1.15 to a minus 2.41. A survey of ratings systems brings us no closer to understanding where this fund is placed. OBSR awards it an AA rating and it bears the imprimatur of Patrick Evershed’s managership, whereas Morningstar and Financial Express consign the fund to their lower ranks. For the purposes of our present exercise, we must go where the data takes us, and again ask the absolute return question: has its return outperformed cash by an acceptable margin?
Finally, Fidelity and SocGen have nowhere to hide. Their funds are strongly correlated to their sector, and we can take an unblinking look at quant performance measures. Their three-year returns run at somewhere near half of the top performers and, while they have both generated positive Sharpe, this is marginal enough to suggest that the gains have ridden on the benchmark’s return rather than any stockpicking successes. The idea is borne out by the negative IRs – either there is too little active management, or else there is insufficient gain per unit of volatility in the activity that was undertaken.