Which Stocks Have Driven UK Equity Fund Returns?

UK equity funds have outperformed the benchmark this year - which companies have contributed to these returns?

Samuel Meakin 9 July, 2018 | 9:03AM
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Tesco is one of the stocks in Schroder Recovery

The average fund in the UK Flex-Cap Equity Morningstar category has outperformed the FTSE All-Share index in 2018 so far. When looking for the factors driving this, one might first consider the market-cap effect – after all, over recent years, an allocation to medium and smaller companies has generally provided a healthy tailwind to many funds in the category.

However, the FTSE 250 index is only marginally ahead of the FTSE All-Share in 2018 to the end of May, and the FTSE Small Cap is behind. Looking stylistically, we can find funds that have outperformed on both the growth and value side. Of the funds in the category rated positively by Morningstar fund analysts, two examples might be Schroder Recovery, which follows a deep value approach, and Royal London Sustainable Leaders, which seeks to identify the best long-term growth prospects that also show ESG leadership or deliver a net benefit to society.

Both funds have outperformed the index and Morningstar category average so far this year. Given that these two different approaches have both been successful over this short timeframe, can we identify certain exposures or factors that might have contributed to excess returns given the market conditions we’ve seen?

The Morningstar Global Risk Model maps each individual stock's underlying exposures to 36 economic factors, including style, sector, region, and currency, which are then aggregated at the fund level. The model allows us to shed more light on fund performance and gain further insight into what factors are at play when it comes to sources of returns. As funds with meaningfully different approaches, Schroder Recovery and Royal London Sustainable Leaders differ in their exposure across a number of factors in the model.

For example, the latter has positive exposure to economic moat, which measures the strength and sustainability of a company’s competitive advantages, whereas Schroder Recovery has less exposure to this factor than the index, which is understandable given its value investment process. The model shows us that economic moat has overall been a useful exposure to have so far this year, which therefore constituted a headwind for Schroder Recovery but benefitted Royal London Sustainable Leaders.

For example, Royal London Sustainable Leaders has large positions in several off-benchmark US technology companies with wide moats – Microsoft, Alphabet and Amazon – that have contributed to active performance.

Valuation uncertainty measures the breadth of possible intrinsic valuations for a company, so is likely to be higher for a company whose revenues vary through the ups and downs of the economic cycle than for one whose revenues display sturdy, defensive characteristics. Greater exposure to valuation uncertainty is a fairly common trait for value-focused funds to display, and Schroder Recovery has benefitted from this exposure recently as the factor has provided a premium.

For example, the fund has investments in several UK supermarket chains – Morrisons, Tesco and Sainsbury – where valuation uncertainty has been elevated due to high levels of competition in the space, but these stocks have in fact performed well for the fund so far this year.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Alphabet Inc Class A175.51 USD-1.32Rating
Amazon.com Inc182.62 USD-0.29Rating
Microsoft Corp429.35 USD0.07Rating
Royal London Sustainable Leaders C Acc324.81 GBP-0.34Rating
Sainsbury (J) PLC283.40 GBX0.00Rating
Schroder Recovery Z Acc1.57 GBP-0.94Rating
Tesco PLC311.60 GBX-0.10Rating

About Author

Samuel Meakin  is a fund analyst for Morningstar

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