UK Equity Active Funds Rely On Small Companies

Actively managed UK equity funds are relying on an inherent bias to outperforming smaller cap companies to make returns for investors, new research has revealed, instead of generating alpha through stock picking.

In a study of the UK All Companies and UK Equity Income sectors, published today by asset manager SCM Direct.com, it found that most of these funds’ investments were in small and mid-sized companies. This bias resulted in 100 percent of the equity funds’ and 85 percent of the equity income funds’ performance over five years to the end of June 2015.

Taking away those smaller companies, the report found that “the outperformance for UK All Companies Funds disappeared entirely and nearly disappears for UK Income funds”.

The study revealed that the performance of the largest actively managed sector, the £168 billion UK All Companies sector, as established by the Investment Management Association, closely mirrored a FTSE 100 tracker (55 percent) and a FTSE 250 tracker (45 percent).

It found that only four funds in the collective sample – worth £122 billion – managed to beat the market cap adjusted returns of their fund in that time period.

Gina Miller, co-founder of SCM Direct, said that the research was another “nail in the coffin” for 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 percent of the annual cost (based on a typical tracker charging c. 0.15 percent pa ongoing charge vs a typical UK active fund charging c. 0.85 percent pa ongoing charge),” she said in a statement.

‘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.

Earlier research in June revealed that the number of benchmark-hugging funds which charge actively managed fees have doubled from eight to 17 funds over the past 12 months, according to Morningstar.