Active funds have significantly outperformed the rest of the UK equity market in the last few years but this is more due to them investing in small to medium sized companies than the stock picking skills of their managers, according to new research from SCM Direct.com.
The on-line wealth manager analysed all funds within the UK All Companies and UK Equity Income sectors and came to the conclusion that investing in the right trackers could be more profitable than choosing actively managed funds.
Gina Miller, co-founder of SCM Direct said: “Our research is yet another nail in the coffin of the majority of active funds. Simply buying a combination of a FTSE 100 tracker with a FTSE 250 tracker, closely resembles the performance of a typical actively managed UK equities fund, whilst saving over 80% of the annual cost (based on a typical tracker charging around 0.15% a year with ongoing charge versus a typical UK active fund charging around 0.85% a year ongoing charge).”
‘Following the outperformance of small and mid-cap stocks, many of these stocks now command a premium valuation, compared to their larger peers. This may negatively impact the future returns of many active funds in these two major sectors,’ she added.
SCM Direct’s research
SCM Direct came to these conclusions after testing if active funds were outperforming passive funds simply as a result of their inherent bias towards investing in smaller and medium sized companies. It did this by analysing all funds within the UK All Companies and UK Equity Income sectors, reviewing monthly data, where available, looking at the percentages invested in large caps, mid-caps and small caps.
The average yearly exposure based on monthly data was calculated, to see what return would have been produced had their exposures to small cap, mid cap and large cap simply performed in line with the average similar sized company in each size segment.
Findings from the study
It came up with the following findings:
- Over 100% of out-performance of UK equity funds over the last five years to the end of June 2015, was found to be due to a bias to small and medium sized stocks, within the UK All Companies sector. These funds typically had just 53% invested in the largest UK companies which represent 70% by value of the UK stock market. They typically invested 47% of their funds in smaller/medium sized companies that together represent 30% by value of the UK stock market.
- The performance of the ‘actively managed’ largest fund sector, the £168billion UK All Companies sector, was found to closely follow an investment of 55% in a FTSE 100 tracker, and 45% in a FTSE 250 tracker over the last five years to end June 2015.
- 85% of out-performance of UK equity income funds over the last five years to end June 2015, was due to the same inherent size bias within the UK Equity Income sector. These funds had just 59% invested in the largest UK companies which represent 70% of the stock market by value. They typically invested 41% of their funds in smaller/medium sized companies that together represent 30% by value of the UK stock market.
- Only 2% of the funds analysed (4 out of 179 funds) beat the market five years running, once adjusted for the inherent size bias of each fund.
SCM Direct.com conducted a further in depth study of 179 UK retail active funds in these two popular sectors with a five year track record; the combined assets of these funds was £122 billion. They found that when you strip out the effects of this inherent bias to small and medium sized companies, the outperformance for UK All Companies Funds disappeared entirely and nearly disappears for UK Income funds.
Only four funds in the sample managed to beat the market cap adjusted returns of their fund, in the 5 years.