As FE Trustnet research recently showed, many funds have particular aims and focuses that mean they cannot be fairly compared with some or all of the funds in their sector.
By looking at the alpha – or value – that a fund has added to its benchmark, it is possible to get a better picture of how it has performed in comparison to the market it invests in.
In a previous article, FE Trustnet showed that the IMA UK All Companies sector contains a variety of funds that focus on different parts of the market, and the same is true in the IMA UK Smaller Companies sector.
According to data from FE Analytics the two funds to have added the most value to their benchmark over the past five years are also the two top performers: Fidelity UK Smaller Companies and Liontrust UK Smaller Companies.
The former has added annualised alpha of 17.97 per cent to its FTSE Small Cap ex IT benchmark while the latter has added 12.59 per cent to the Numis Smaller Companies ex IT index.
FE Alpha Manager Alex Wright’s Fidelity fund has returned 180.49 per cent in total over that time, while the Liontrust fund, run by FE Alpha Managers Anthony Cross and Julian Fosh, has made 107.36 per cent.
Performance of funds vs indices over 5yrs
Source: FE Analytics
FE Alpha Manager Giles Hargreave’s £161m Marlborough UK Micro Cap Growth fund uses the sector average as its benchmark.
For the reasons mentioned above, this is not necessarily a useful statistic to use, and in this case it actually understates the performance of the fund.
The fund comes out third in the table with annual alpha of 12.35 per cent when it is tracked against the FTSE Small Cap ex IT index.
The fund scores 8.54 per cent when compared against the sector average. Hargreave’s fund concentrates on the smallest companies in the market, typically those worth less than £100m.
This makes it questionable whether the broader FTSE Small Cap index is appropriate, but there is no realistic alternative.
This highlights the importance of examining each fund on a case-by-case basis rather than with a simple comparison to the sector.
Hargreave’s fund has some of the highest returns in the sector over three and five years, but the next best performer comes nowhere near the top quartile: the £10.2m Close Beacon Investment fund, run by Deryck Noble-Nesbitt.
Nesbitt’s fund has added annualised alpha worth 12.04 per cent to its FTSE AIM benchmark over the past five years, making it the best-performing of the AIM funds in the sector.
Although it is in the fourth quartile of the sector over five years, with returns of 39.7 per cent, the FTSE AIM index has lost 24.17 per cent over this time.
Noble-Nesbitt took over the fund in October 2008, meaning that he is responsible for the majority of these returns.
The fund has also significantly outperformed the index over one and three years.
Performance of fund vs index over 5yrs
Source: FE Analytics
The fund has added more value to the performance of the AIM benchmark than any of the other funds to concentrate on that market, none of which appear in the top-10.
However, investors should be aware that the FTSE AIM index frequently has a high weighting to certain sectors that may have particularly bad or good periods.
This makes the index more volatile and theoretically easier for managers to beat by avoiding these sectors. Managers still need to make these calls, however.
For example, the large number of commodities companies listed on the AIM index has dragged down performance recently, as the sector has had a torrid few months.
Cazenove UK Smaller Companies, run by FE Alpha Manager Paul Marriage has added 11.86 per cent annualised alpha to its FTSE Small Cap ex IT benchmark, and is the only other fund to have an alpha score in double figures over this time.
Funds with the highest annualised alpha over 5yrs
Source: FE Analytics
The rest of the funds in the top-10 focus on the general smaller companies index, except for the £5.3m CF Progressive UK Smaller Companies fund, which takes the FTSE 250 index of mid cap stocks as its benchmark.
It invests in both small and medium-sized companies.
This has been a harder benchmark to beat over the past five years, as the mid cap part of the market has rallied, returning 53.22 per cent while the FTSE Small Cap ex IT has made 33.33 per cent.
The AIM fund with the next-best results is Paul Mumford’s £19.9m Cavendish AIM portfolio.
This has added alpha worth 6.59 per cent a year to the index, the 11th-best figure in the sector.
Octopus Micro Cap Growth and PFS Downing Active Management also invest in the AIM, but take custom benchmarks split between the indices of that market and the small cap market.
The Octopus fund has produced annualised alpha worth 2.84 per cent against a benchmark split 50/50 between the FTSE AIM and FTSE Small Cap indices.
PFS Downing Active Management was launched only in September 2009, but over four years it has added alpha worth 1.29 per cent to its benchmark, which has a 60 per cent weighting to the FTSE AIM index and 40 per cent to the FTSE Small Cap.