It is by no means a secret that active managers continue to face mounting pressures, primarily relating to underperformance and passive alternatives.
Without adding further to the active versus passive debate, our immediate interest is in reviewing the performance of active management across the Investment Association (IA) sectors. Surely some managers avoided the active bashing of 2016 – if not by way of idiosyncratic risks and skill, then perhaps through exposure to different market drivers that could allow for ripe, low-lying alpha picking.
FE calculated the investment sectors’ relative performance by simply taking each group’s average return against its corresponding benchmark. We excluded a few sectors such as Mixed Assets or Targeted Absolute Return due to the diversity in their composition, and the results threw up some surprises and some unflattering observations. Of 23 sectors analysed, only four outperformed their benchmark – a measly 17.4 per cent.
The most striking observation is the failure of active UK equity managers to outperform their indexCharles YounesThe situation worsens when digging deeper into the performance of these four sectors. It appears that active government bond managers have outperformed, but it is significant that duration managers formed part of that cohort, even though many have called for the end of duration. The simple reason is their investment mandates forced some to run long duration in their portfolios.
Looking at the nine funds that outperformed the FTSE UK Gilts All Stocks index last year, four have a long-duration mandate, and a further three have an income distribution mandate which forces them to pick higher-yielding, long-dated bonds. So there is simply no active decision to reward there.
The average active managers within the IA Japanese Smaller Companies sector also outperformed, even though one caveat would be the small size of this grouping. Considering the recent clamour for Japanese stocks following modest improvements in fundamentals and a weakening yen, we half expected the managers to outperform and not just match their benchmark. The explanation is similar for the IA Asia Pacific including Japan equity sector, which is too small (seven funds) to be taken into consideration. We should also note that active managers within the larger IA Asia Pacific ex Japan peer group failed on average to outperform their benchmark.
But the most striking observation is the failure of active UK equity managers to outperform their index. Although UK equity income managers can explain their underperformance due to their defensive bias, it is hard to justify why just 17.6 per cent of these managers managed to outperform the FTSE All-Share index. The excuse of the Brexit vote is most often used to justify their poor performance, but do you pay an active fee for a manager to take a political risk?
In the IA North America equity sector, 41 per cent of the managers have managed to outperform the S&P 500 index. Was the Trump victory better forecasted than the Brexit vote? This clearly highlights a failure of UK equity active managers to accurately understand the drivers of performance and the risks they are taking. A good risk management system should have highlighted that the portfolio performance is too sensitive to a certain industry or market-cap performance.
We believe active UK equity managers focus too much on individual companies and their fundamentals, rather than trying to construct a portfolio in which risks are accurately assessed. Too much time on single names – and not enough on the overall portfolio shape!
A portfolio is not just the sum of the parts, and active UK equity managers paid for it in 2016.
Charles Younes is research manager at FE
