Indeed, while the volatility statistics for indices overall have been surprisingly low, there has been a huge upheaval below the surface, with dramatic implications for fund performance.
The scale of underperformance from pure value funds in 2015 was so extreme they looked ripe for a bounce back – which duly happened. Within the IA UK All Companies sector, Schroder Recovery, a disciplined value offering, was transported from the tenth decile to the first decile in 2016, with no material changes to the underlying portfolio.
On the other side of the coin, the cohort of mid-cap growth funds in the sector experienced pretty much the opposite journey.
Although it may seem a strange thing to say, we applaud the underperformers as much as the outperformers when such contrasts are pre-ordained by clear stylisation and market-cap profiles. When we look at funds in this way, we can observe consistency. However, it is consistency in patterns of behaviour we observe, not in performance rankings.
It is for this reason basic quantitative screening has its limitations. It is difficult to judge whether a fund’s outcome is good or not unless you know what the manager is trying to accomplish and the way in which they are trying to do that.
There is also the risk that screens simply highlight the more stylised funds that have been performing well for the longest and are most at risk of a period of underperformance.
Of course, market action – not to mention policymakers – can still surprise us. For example, we would not ordinarily expect income-biased funds and mid-cap growth funds to be performing well simultaneously. However, as interest rates fell and the search for yield intensified, more defensive, cash-generative sectors within the UK market were very much in favour.
At the same time, with economic growth scarce, companies with structural growth credentials – typically more prevalent in the mid-cap arena – were also beloved of investors. So holding Invesco Perpetual Income and Old Mutual UK Mid Cap in 2014 and 2015 would have provided a happy outcome, if a somewhat surprising one.
“Although it may seem a strange thing to say, we applaud the underperformers as much as the outperformers…”
We saw a different picture in 2016, which was a poor year for active managers overall. After a tough first quarter for risk assets, commodity prices began to recover and investors dared to believe economic growth was not as elusive as feared. This breathed life back into value-biased and contrarian funds.
However, little could prepare managers for the market shenanigans of the EU referendum. Very few thrived in this period. If they did, it was more likely a function of running a structurally large-cap, sterling-sensitive portfolio, full to the brim with international earners.
So, where are we now? Growth is back so far this year, so the top of the table features growth and mid-cap biased funds. Value-biased funds have returned to the bottom rungs. The year began in enthusiastic style for equity markets but recent weeks have seen the bears gaining the upper hand as investors question Trump’s ability to usher in stimulative policies, military tensions rise and European politics make the headlines.
We agree there are good reasons to take a cautious approach. The UK market is not as expensively valued as the US but it is certainly in an elevated state, which makes it more vulnerable to earnings disappointments and global uncertainties. Any recovery in the value of sterling would also place a cap on the market.
Individually, many of the funds in this sector will not give you the smoothest of journeys compared with the index (passively managed funds can do that for you) but a robust blend gives good managers the oxygen required to deliver their performance goals over the longer run.
Funds can be in favour or they can be out-of-favour; your main concern is that they continue to perform the designated role within your portfolio.
Gill Hutchison is research director at The Adviser Centre