Fund pickers point to the toxic combination of the FTSE 250 being weak as miners and oil stocks surge.
UK equity funds have been beset by outflows for many years now. Since the pandemic, however, they have been performing unusually badly.
Over the past three years, 80% of active managers have underperformed the FTSE All-Share index, according to Morningstar data provided to Citywire by Canaccord Genuity Wealth Management.
That is a huge spike from the historic rate, which is closer to 50%, according to Kamal Warraich, head of equity fund research at the firm.
The data is based on performance in the IA UK All Companies sector over the three years to the end of June.
The average UK equity fund gained 23.5% over that period – which encompassed the post-pandemic recovery, revival of inflation and the war in Ukraine – while the FTSE All-Share returned 33.2%, including dividends reinvested.
Much of the clamour around active fund underperformance focuses on the US market and the notoriously hard-to-beat S&P 500, but Warraich said it had been easier for UK stockpickers to beat the benchmark.
One reason is that we have quite a cyclical index,’ he said. ‘With the FTSE 100, you can invest in some of the more pro-quality and growth names and outperform it. You can also invest in the [FTSE] 250 names and lots of managers are overweight mid-caps in the UK, so there is a reason behind the underperformance.
‘But this year it’s been stark and the backdrop has been quite painful for equity managers.’
Richard Warne, senior portfolio manager of Copia Capital, noted that the FTSE 100 had been a relatively strong performer in 2022 compared with global indices. But he pointed out that this was driven by specific sectors, mainly energy and miners, which gained 42% and 23%, respectively.
‘The rest of the UK market outside of the FTSE 100 delivered negative returns,’ he told Citywire Wealth Manager. ‘Small caps and mid-caps were down 20%. And if you looked more closely at the FTSE 100, it was predominantly the top 20 that delivered a positive return.
‘The rest was negative or flat at best. There has been a general selling pressure on the asset class over many years. And secondly, over the last 12 months, it’s been hard to outperform when there is such narrowness in the market.’
Warne feels that miners, energy stocks and banks are still best placed to deliver returns in the current climate, meaning investors who do not have a defined value or income orientation will continue to face headwinds.
Though UK small caps and mid-caps have not endured a similarly disastrous 2023, they have also seen little to no recovery.
At the end of last week, the FTSE 250 was down 1.9% in the year to date versus flat returns for the All-Share, according to Morningstar.
While persistent outflows from UK funds have often been put down to macro or political factors like Brexit, portfolio managers tend to make the case that investing in UK equities is very different from betting on the British economy.
However, Tineke Frikkee, head of UK equity research at Waverton Investment Management, said that since much of the underperformance of active funds has been driven by allocations to the FTSE 250, a domestic revival would help to reverse that trend.
‘For the whole FTSE 250, about 51% of sales are here in the UK, so what happens to the UK economy is extremely important,’ she said.
To access UK equities, Copia’s Warne has invested in the £418m GAM UK Equity Income fund managed by Adrian Gosden.
Over the three years to the end of July, the fund (which ranks fourth out of 89 funds in the Citywire UK Equity Income sector) returned 65.4% versus the 34.3% average.
Gosden, whose biggest holdings include GSK and HSBC, is an income manager with a value tilt.
‘Gosden will invest up and down the market cap spectrum – typically 50% FTSE 100, then 50% in mid-caps and small caps, so you get a nice blend in terms of market cap exposure,’ Warne said.
‘Although UK equities have been out of fashion in the last five years – and within that, value has been out of fashion – Gosden’s stock selection has delivered outperformance.’
A pick that Warraich is bullish on is Nick Train’s £4bn Lindsell Train UK Equity fund.
‘It is the tilt back to quality as a factor away from value, as value has underperformed growth and quality this year, significantly, after it had a couple of good years,’ he said.
Despite stronger performance during the last year, Train has still underperformed over three. His UK fund has delivered 19.1% over 36 months to the end of July, behind its 29.4% Citywire sector average.
The original article can be found on City Wire