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OPINION

Brexit blow to funds

Brexit blow to funds
July 12, 2016
Brexit blow to funds

In the last month, less than a quarter of the 256 funds in Trustnet's database of all companies unit trusts have beaten L&G's UK index, and even fewer have beaten FTSE 100 trackers. Several previously great performers - mostly midcap funds - have had a terrible few weeks. Standard Life's UK equity unconstrained fund, for example, has lost over 14 per cent in the last month, having been one of the best-performing funds in the previous 10 years.

There's a simple reason for this. Brexit triggered a shift out of domestic cyclicals, many of which had done well since 2010, and into overseas earners and defensives.

This didn't just reverse the pattern of recent years, thus wrong-footing many funds. It also means that a handful of mega-cap stocks have beaten the market significantly. Because market indices are weighted by market capitalisation, this implies that most stocks have underperformed. In fact, in the last month just five stocks - BP, Royal Dutch, BAT, Rio Tinto and AstraZeneca - account for almost four percentage points of the 5.4 per cent rise in the All-Share index.

Funds that were underweight in just a few stocks, therefore, have underperformed index trackers.

What's more, this means that the tide suddenly turned against active managers. In 2014-15 the falls in prices of big resources stocks dragged down the All-Share index and meant that most shares out-performed the market. That meant that even a clueless fund manager who picked shares at random would probably have beaten the market. In the last month, though, the opposite has been the case. Most stocks have fallen, and so luck has turned against stock-pickers.

Will this continue to be the case? It will if sterling continues to fall and if uncertainty causes a further shift towards defensives: the latter often happens in the summer months. On the other hand, though, if the economic downturn proves less severe than economists expect, midcaps could enjoy a relief rally, to the benefit of active managers.

Personally, my suspicion is that - in the long-run and on average - Gibrat's law more or less holds for listed companies: growth is independent of size. If this were not the case, we'd end up with either a handful of massive monopolies or a flat corporate landscape with firms of equal size, and neither seems plausible. This implies that, on average, mega-caps should perform roughly in line with other stocks, so active managers will have neither the good luck they had in 2014-15 nor the bad they've had in the last few weeks.

Futurology, though, is not the point. Instead, the point is that the case for active stock-picking - by professionals or retail investors - isn't simply that some people are clever enough to beat the market: such a view implies that many hitherto good fund managers suffered a loss of ability a few weeks ago, which is unlikely. Instead, it should be that market conditions sometimes favour stock-picking: when mega-caps under-perform, most stocks beat the market and so most active stock-pickers should do so. These conditions, however, have been absent recently and we cannot say whether they'll return.