It is generally believed that fund managers, being, for the most part, the market in aggregate, cannot consistently outperform – not on a gross basis, and most certainly not on a net, after-fees, basis.
However, in comparing the performance of UK equity fund sector indices, including those calculated by Morningstar and by the Investment Association, both of which are net of management fees, to the performance of various FTSE indices, the annualised returns appear to show that UK equity managers have actually performed very well over most periods up to 15 years.
Quite remarkably, the average return of all IA UK Equity fund sectors; All Companies, Income and Smaller Companies, is greater than the relevant FTSE benchmark over all of the time periods shown, one, three, five, 10 and 15 years, and this is after managers’ fees. UK equity fund managers have clearly delivered and their marketing departments are not slow to make the point.
A good part of the explanation for this is one particular tailwind, enjoyed over this 15-year period, which has benefitted from a structural feature of the UK market. The largest 10 stocks in the UK market have typically represented almost 50% of the FTSE 100 index and the FTSE 100 index has performed much worse than the rest of the UK market. This is most clearly seen in the 15-year annualised returns of 9.77% for the FTSE 250 index and 3.59% for the FTSE 100 index.
This difference of more than 6% per year over 15 years, in performance between the indices for large and mid-cap stocks, is remarkable for both its scale and its longevity. By overweighting mid-cap stocks in their portfolios, which for many managers is a natural function of their approach, focussing on smaller, under-appreciated companies, the structural boost to performance has been enormous.
How Stock Market Performance Influences Data
When the largest stocks in an index perform consistently poorly over time, it becomes easier for a manager to be zero or low weight in these underperforming stocks, leaving them space in their portfolio to be weighted in smaller, better-performing stocks. In the FTSE 100 index the largest stocks have tended to be found in the Oil & Gas, Banking, Mining and Pharmaceutical sectors, which have been substantial laggards over much of this period.
The small cap managers also appear to have performed well, but for many, the FTSE Small Cap index is not the best reflection of how they invest, reflecting as it does only the bottom 3-4% of the FTSE All Share, whereas the Numis 1000 covers approximately the lowest 10% of the All Share. Smaller Companies managers are also naturally overweight in mid-cap stocks.
This natural overweight to mid-cap stocks across the industry suggests that outperformance cannot be wholly attributed to skill. However, the performance of the Morningstar UK Mid-Cap sector, where this effect should not be present, and where managers have delivered outperformance after fees over all time periods apart from the 15-year comparison, would appear to indicate manager skill.
Most remarkable is the performance of the UK Equity Income sector – the higher yielding stocks are increasingly concentrated in the FTSE 100, but managers of funds in this category have delivered higher than average income and market outperformance over a sustained period.
originally published in Investment Adviser
