Another year, another surge in assets for the UK’s biggest funds. In September 2020 we noted that Fundsmith Equity (GB00B4Q5X527) had more than £20bn in assets, with Scottish Mortgage Investment Trust (SMT) commanding a market capitalisation in excess of £14bn. A little over a year later, Terry Smith’s flagship fund now has more than £27bn in assets and Scottish Mortgage has swelled to more than £21bn.
Greater fund size does confer advantages, from economies of scale and potentially lower fees to greater clout with investee companies. But taking on substantial assets can also put a brake on performance for some portfolios. Many funds have enjoyed their best returns while they are still small and nimble, with a manager focused on producing the best returns rather than managing substantial assets.
With this in mind, we have again (see September 2020 and a year before that) sought to identify smaller funds with outstanding levels of risk-adjusted outperformance (also known as the information ratio). These funds could give portfolios an edge and lessen your reliance on bigger names.
As ever, our list should be a starting point for further research rather than anything final. It should also be noted that smaller funds come with their own drawbacks, from a risk of closure to higher operating costs that can feed into hefty charges. Our 'Methodology' box below explains the nuances of the process used to unearth the funds.
2021’s hidden gems
We have once again picked out 10 promising names, but there are some notable changes in the latest table, beyond the usual turnover.
While we seek to identify promising but overlooked funds from across the main equity fund sectors (including smaller company peer groups), the US is not covered in the table because the information ratios from the group were simply too low. While nine funds from the Investment Association’s (IA) North America and North American Smaller Companies sectors met our size requirement of having more than £10m but less than £100m in assets, none of them had an information ratio of 0.4 or higher. We have therefore bulked out some of the other categories, listing three global equity funds with impressive risk-adjusted returns and adding an extra Asia fund into the mix.
Last year the most impressive measure of risk-adjusted outperformance tended to come from funds operating in markets that looked troubled in the early days of the pandemic, from UK funds to European equity portfolios. This time we could be seeing a similar trend: the smaller fund scoring highest is Fidelity Japan (GB00B882N041), which has certainly thrived against the backdrop of an unexciting market. While Japan’s Topix index has lagged many other markets in recent history and delivered a sterling total return of just under 20 per cent in the three years to 21 September 2021, the Fidelity fund has made nearly 50 per cent.
|10 funds punching above their weight|
|Sector||Fund||Three-year annualised information ratio versus benchmark||Size (£m)||Ongoing charge (%)|
|Asia||Allianz Total Return Asian Equity||1.01||70.19||1.01|
|Asia||Matthews Asia Small Companies||0.78||57.71||1|
|Emerging markets||Martin Currie Emerging Markets||0.56||41.27||1.01|
|Global||BNY Mellon Sustainable Global Equity||0.81||77.82||0.82|
|Global||BNY Mellon Global Leaders||0.77||56.52||0.88|
|Global||Montanaro Better World||0.67||86.2||1*|
|UK growth||MFM UK Primary Opportunities||0.61||27.18||0.87|
|UK growth||Rathbone UK Opportunities||0.46||74.71||0.74|
|Source: FE Analytics, fund factsheets|
|*For accumulation share class. 0.85% for income share class|
The fund’s manager, Ronald Slattery, has a bottom-up investment approach with something of a value bias, focusing on stocks that are “undervalued relative to their balance sheet quality, cash flow and earnings growth potential”. The fund has a reasonable spread of holdings, with 81 investments at the end of August and some 36 per cent of the portfolio in its top 10 positions. Its biggest positions at the time included electric appliances company Hitachi (JAP:6501) and transportation equipment specialist Denso (JAP:6902). The fund is managed without reference to a benchmark.
The fund with the second-highest information ratio, Allianz Total Return Asian Equity (GB0031384257), also operates in a market that has had its share of trouble. Recent months, in particular, have been challenging for Asia and emerging market investors on the back of upheaval in China. The Allianz fund has not been immune to this: at the end of August it had more than 42 per cent of its assets in China, with Tencent (HK:0700) and Alibaba (HK:9988) making up around 14 per cent of the portfolio, and performance has been poor in recent months – yet over three and five years it has delivered strong returns.
While the investment team backs a number of popular Asia and emerging market stocks, from China’s tech giants to Taiwan Semiconductor Manufacturing (US:TSM) and Indian banking giant HDFC Bank (US:HDB), the fund’s literature suggests the managers have something of a contrarian bent. The fund aims to maximise total return by investing in high-yielding or undervalued shares. The current upheaval in China and beyond could present opportunities for the team.
Readers of last year’s analysis may remember some Asian and emerging market funds from last year's selection. Matthews Asia Small Companies (LU0871674379) and Martin Currie Emerging Markets (GB00BYWDTB80) have grown notably but remain fairly small, and maintain information ratios that are still high, if lower than a year ago.
Closer to home
When it comes to UK stockpickers, two names from last year’s list continue to have strong levels of risk-adjusted outperformance but have exceeded our size threshold. Liontrust UK Micro Cap (GB00BDFYHP14), run by the team behind Liontrust Smaller Companies and Liontrust Special Situations, now has more than £200m in assets. Slater Recovery, which featured in our list of small outperforming funds for two years in a row, recently had around £340m in assets.
The two new UK names on our list are MFM UK Primary Opportunities (GB0009606988) and Rathbone UK Opportunities (GB0030430804). The former is particularly interesting because its emphasis on “natural primary opportunities” to buy into companies translates into a focus on share placings, sales by strategic or forced sellers, initial public offerings (IPOs) and investing when prices are depressed by a large supply of new shares. Given that retail investors can still find themselves locked out of some IPOs and placings, this might be a less direct way in.
We sought funds with more than £10m but less than £100m in assets. This partly relates to a heightened risk than funds with less than £10m might close or merge into other products, while funds that pass the £100m mark tend to attract the attention of some bigger investors and can grow more rapidly. Asset growth is not necessarily bad, but funds can reach a point where size is a problem.
From those names of an appropriate size, we have picked out funds that appear to be widely available to retail investors with high annualised information ratios versus their benchmark over three years. We prefer the information ratio to other metrics because it measures outperformance but also accounts for the level of risk a manager has taken to deliver it. A ratio of 0.4 or higher tends to indicate a level of manager skill.