Past performance is of course not a guide to the future, but it is important to know how a fund is performing compared with its peers.
It is impossible to judge a fund on absolute performance alone and so categorising funds – in IMA or IT sectors, for example – is a good way of putting returns into context.
While these sectors are certainly helpful, head of FE Research Rob Gleeson (pictured) says that investors need to delve even deeper to make sure that funds are fairly judged.
He points out that certain funds are either placed in the wrong sector, or have a certain bias or tilt that makes comparisons unfair. He highlights the five crown-rated Unicorn UK Income fund, headed up by John McClure, as a good example. "Some funds look good because they’re in the wrong sector, but sometimes it’s just that there’s ambiguity surrounding what exactly it is," he said.
"Take Unicorn UK Income, for example. It’s both a UK equity income fund and a UK smaller companies fund, and so could be in either sector."
Gleeson says there is no hard and fast way of putting funds in the right sector, but thinks looking at a fund’s benchmark is a good place to start.
"If you look at a fund that’s performed really well, you need to ask yourself why it’s done it," he said.
"If it’s not about the stockpicking, but because what the fund tends to be invested in, then that’s a sign that you need to investigate. If the sector and benchmark have little correlation to each other, that will tell you a lot."
He adds that a fund's benchmark is not always reflective of what it invests in, illustrating the importance of looking under the bonnet of funds and seeing what they hold.
With this in mind, FE Trustnet highlights some sector-leading portfolios that require closer inspection.
UK equity income
Unicorn UK Income has been the standout UK Equity Income fund of the last five years and arguably the standout UK equity portfolio full-stop.
Our data shows it is number-one in its IMA UK Equity Income sector over one, three and five years and has smashed the returns of its FTSE All Share benchmark in the process.
However, on closer inspection, the fund is very different from the average UK Equity Income fund. Like the All Share – the sector’s natural benchmark – the average fund in the sector has a large cap bias, which is a far cry from FE Alpha Manager McClure’s fund, which is predominantly invested in small, mid and micro-cap companies.
No company in Unicorn UK Income’s top-10 is in the FTSE 100, with the majority in the FTSE 250, FTSE Small Cap and FTSE AIM indices. For this reason, there is a case for it sitting in the IMA UK Smaller Companies sector.
Performance of fund vs sectors and indices over 5yrs
Source: FE Analytics
As the graph above shows, the fund has still significantly outperformed the IMA UK Smaller Companies sector average and its natural benchmark – the Numis Smaller Companies ex IT index – but the gap is much smaller.
It is also worth pointing out that the fund is less dominant if placed in the UK Smaller Companies sector. Over three years, seven UK small cap funds have beaten it, and over five years two have beaten it.
Alex Wright’s Fidelity UK Smaller Companies fund has prevailed on both occasions. Of course, funds of this type do not have an income focus and so comparison is once again flawed, but it is interesting to note that the fund loses its sparkle – if only a little – when compared with another possible peer group.
It is a similar story with another very strong competitor in the IMA UK Equity Income sector – PFS Chelverton UK Equity Income. Again, this fund is very much a small cap portfolio, even though it uses the FTSE All Share as its benchmark.
Manager David Taylor told FE Trustnet that he would never invest in a FTSE 100 company, as he sees his fund as a good diversification option for more mainstream UK Equity Income funds.
It is a top-quartile performer in the IMA UK Equity Income sector over one, three and five years. If it sat in the IMA UK Smaller Companies sector, it would still be first quartile over one year, but would drop to the second quartile over three and five.
UK growth
In a sector comprising nearly 300 funds, it is hardly surprising that there are a number of different strategies on offer in IMA UK All Companies. This is why many experts suggest investors ignore the sector average altogether.
Mid cap funds that use the FTSE 250 index as their benchmark dominate the performance tables over the short-, medium- and long-term.
Franklin UK Mid Cap and Old Mutual UK Mid Cap are the two best-performing funds in the sector over 10 years, with returns of 500 and 415.12 per cent, respectively.
Schroder UK Mid 250, Allianz UK Mid Cap and Premier UK Mid 250 are also top-decile performers over the period.
In the shorter term, Mark Martin’s Neptune UK Mid Cap has been a very strong performer. While the funds are very strong in sector terms, their performance is less impressive when compared with the market they are invested in.
Performance of funds, sector and index
| Name | 1yr | 3yr | 5yr | 10yr |
|---|---|---|---|---|
| Franklin UK Mid Cap | 24.4 | 59.47 | 97.47 | 500 |
| Old Mutual UK Mid Cap | 31.75 | 53.01 | 71.92 | 415.42 |
| FTSE -250 Index | 25.4 | 44.06 | 62.44 | 342.08 |
| Allianz UK Mid Cap | 24.9 | 43.67 | 55.45 | 298.97 |
| Premier UK Mid 250 | 26.98 | 37.44 | 47.51 | 274.75 |
| Schroder UK Mid 250 | 34.53 | 47.82 | 41.88 | 262.94 |
| Aberdeen UK Mid Cap | 28.98 | 53.88 | 64.38 | 248.58 |
| IMA UK All Companies | 19.37 | 28.27 | 32.1 | 149.83 |
| Threadneedle - UK Mid 250 | 26.75 | 47.07 | 62.98 | N/A |
| Neptune UK Mid Cap | 34.75 | 82.8 | N/A | N/A |
| F&C UK Mid Cap | 28.18 | 60.81 | 81.59 | N/A |
| Royal London UK Mid-Cap Growth | 24.92 | 62.03 | 108.44 | N/A |
Source: FE Analytics
Of the seven UK mid cap funds with a 10-year track record, only the Franklin and Old Mutual funds have outperformed the index over the last decade. Over one, three and five years, about half of the funds with a long enough track record have outperformed.
While these are relatively easy to pick out, there are a number in the sector that do not officially refer to themselves as mid cap funds, and some that do not use a mid cap index.
Mark Slater’s MFM Slater Growth fund is a good example. The mid cap focused growth portfolio is a top-decile performer in the sector over three and five years, with returns of 69.18 and 117.81 per cent, respectively.
It uses the FTSE All Share as its benchmark and, although it has also outperformed the FTSE 250 over both periods, it has done so by a smaller margin.
The same can be said of a number of recovery funds in the sector which, given their remit, tend to avoid the blue chip companies that dominate the FTSE 100. The likes of Schroder Recovery and Rathbone Recovery are good examples.
The small cap focused Cavendish Opportunities fund, which is a top-quartile performer in the sector over three, five and 10 years, is another that warrants closer inspection.
Global
The trend is not exclusive to the UK market, though; there are plenty of cases in the IMA Global, Global Emerging Markets and various regional sectors.
Unsurprisingly, it is the issue of market cap that tends to throw investors when looking at performance tables.
There is no "global smaller companies", "global emerging markets smaller companies" or "Asia Pacific ex Japan smaller companies" sectors because the IMA does not believe there is enough demand for further categorisation.
This means that certain funds look very good in their sector, even though they differ significantly from the sector average.
McInroy & Wood Smaller Companies is a good example in the IMA Global sector, and it is the same story for Aberdeen Global Asian Smaller Companies in the IMA Asia Pacific ex Japan sector.
The latter has actually beaten its MSCI AC Asia Pacific ex Japan Small Cap benchmark by an even greater margin that its sector and index over three and five years, but it is still worth bearing in mind that it has a very different universe from its peers.
While there are small cap sectors dedicated to regional markets such as the US, Japan and Europe, some small cap focused portfolios still find themselves in the core sector.
The Legg Mason Japan Equity fund, which has led the IMA Japan sector during the recent rally, is a good example. While it sits in this sector, it typically invests towards the smaller end of the scale.
It would have still easily beaten its peers year-to-date if it sat in the IMA Japanese Smaller Companies sector, but the gap does narrow quite significantly.
Performance of fund vs sectors over 3months
Source: FE Analytics
The fund is far more correlated to the IMA Japanese Smaller Companies sector average than IMA Japan: our data shows it has a correlation of 0.76 to the former over three years, and only 0.53 to the latter.
It is not just size that can serve to misguide investors when looking at performance tables: the particular style or focus of a fund can also skew results.
A manager can go underweight or overweight a sector at any one time depending on their outlook, which is of course part of being a good investor.
However, certain funds have a specific focus written in to their objective and even their name, which they will retain no matter what the manager thinks will perform well in the future.
Graham French’s M&G Global Basics fund is a good example. At the moment it is languishing towards the bottom of the performance tables over one, three and five years due to the poor performance of commodities, which it is heavily exposed to.
However, it tends to shoot to the very top of its IMA Global sector when returns are strong in this area.
The same can be said of funds with a specific focus on global brands, such as Morgan Stanley Global Brands, or healthcare, such as Schroder Global Healthcare.