To get the best risk-adjusted returns out of your portfolio, it is not enough to simply make your asset allocation decision by picking the top-performing funds in each asset class.
That approach will mean you are only ever buying yesterday’s success story, and betting on the manager being able to predict the future course of markets or adjust quickly and appropriately.
It also means you miss out on a whole aspect to diversification that isn’t captured in asset allocation models: the diversification benefits of active strategies.
Diversifying the active strategies in your portfolio should allow you to gain the same returns with less risk.
Here we look at some varied strategies in smaller company sector, an area with an excellent recent track record and some outstanding FE Alpha Managers with varying approaches.
Marlborough Special Situations
FE Alpha Manager Giles Hargreaves’ £578m portfolio employs a number of highly-experienced analysts who each make recommendations to the manager on the stocks they think he should buy in their sector.
The fund has a large number of holdings, almost 250 at the time of writing, widely spread across different sectors, and keeps each position down to a maximum of 3 per cent of the portfolio.
This is in contrast to the approach of many other managers in the sector, such as FE Alpha Manager Harry Nimmo, who like to “run their winners”, even when they become larger than a typical small-cap company.
Hargreave’s team look for recovery stories, and have a weighting to those with high predicted growth over the coming 12 months, according to data from FE Analytics.
Marlborough Special Sits has produced outstanding returns over the longer run, making 612.75 per cent over the past decade, compared to just 276.55 per cent from the IMA UK Smaller Companies sector.
Performance of fund versus sector over 10yrs
Source: FE Analytics
The fund has a minimum initial investment of £1,000 and ongoing charges (OCF) of 1.53 per cent.
Liontrust UK Smaller Companies
This £153m fund, which has five FE Crowns, is run by FE Alpha Managers Anthony Cross (pictured) and Julian Fosh in accordance with Cross’ belief in the superior returns available from companies with strong competitive advantage in their sector.
This gives it a strong bias towards certain sectors such as technology and pharmaceuticals. Data from Style Research shows it has a higher weighting to the healthcare and technology sectors than the Marlborough fund.
According to the FE Research team, the competitive advantage of the companies the fund buys is particularly effective in times of economic crisis, and that is borne out by our data.
Liontrust UK Smaller Companies has rocketed ahead of Marlborough Special Situations over the past five years, returning 108.55 per cent as the Marlborough fund has made just 86.62 per cent.
However, the Marlborough fund massively outperformed the Liontrust in the five preceding years, making 282.54 per cent compared to 105.57 per cent, when Cross and Fosh’s fund actually lagged the sector.
Performance of funds versus sector over 10yrs
Source: FE Analytics
The fund has a minimum initial investment of £1,000 and the OCF is 1.68 per cent.
Cazenove UK Smaller Companies
Both this £406m fund and the Liontrust fund have a higher weighting to micro-cap stocks than the Marlborough fund – Hargreaves saves most of such ideas for his dedicated Micro-Cap fund.
It has much less of a value focus than the previous two funds, and FE Alpha Manager Paul Marriage and John Warren are happy to hold expensive stocks if they believe in their potential.
The managers look for companies that they think have the potential to grow into the leading firms in the country in their sector.
The fund has the best returns of any in the sector over the past three and five years, having more than doubled the returns of the FTSE Small Cap ex IT benchmark over both periods.
Performance of fund versus sector and benchmark over 3yrs
Source: FE Analytics
The minimum initial investment is £1,000 and the OCF is 1.61 per cent.
PFS Chelverton UK Equity Income
This £67m fund, which has five FE Crowns, sits in the IMA UK Equity Income sector, but it chases yield in the small-cap area of the market.
This means that, regardless of the income it provides, it invests in different areas of the market from the other funds on this list, balancing out the sectors and styles they overlook.
The fund has been managed by David Horner and David Taylor since launch in 2006, and has very little in healthcare or technology, but higher weightings to utilities and telecoms, which are almost absent entirely from the other portfolios.
It invests in areas of the market with lower growth than the three other portfolios, as these are the sectors with the better yields.
Over the past three years the fund has managed to outperform the average UK smaller companies fund, returning 71.44 per cent as the IMA UK Smaller Companies sector has made just 55.94 per cent.
Performance of fund versus sector over 3yrs
Source: FE Analytics
PFS Chelverton UK Equity Income has a minimum initial investment of £1,000 and the OCF is 1.88 per cent.
In the previous article in the series, FE Trustnet explored how investors can properly diversify their UK growth exposure.