How to pair funds and beat the market

The success of the 'Magnificent Seven' stocks made it undeniably difficult for active fund managers to beat the market this year, but that's not to say they have missed out entirely. Those with a growth bias, who are more likely to back the likes of tech stocks, have seen a return to form as companies seen as artificial intelligence (AI) plays soar. 

That's amply demonstrated by the performance of global indices with different style tilts: the MSCI World Growth index, with allocations of more than 9 per cent apiece to names such as Apple and Microsoft as of the end of January, made a sterling total return of nearly 30 per cent in 2023. That left the conventional MSCI World index and its value-oriented equivalent in the dust. The value index had an allocation of just 9 per cent to the information technology sector at the end of January, versus the growth index's near-40 per cent weighting.

All of this raises the subject, once more, of the role different investment styles play in a portfolio, and the question of how to balance these out. In reality, the results can be mixed. Analysis we carried out in 2022 showed that holding a growth fund and a value fund, as opposed to holding the broader market index, had not always panned out in previous years. A fresh assessment of the situation shows that attempting to beat a skewed market by combining styles remains a difficult task.

Our methodology involves looking at three common equity universes – the global market, the UK and Europe – and pairing a growth and a value fund in each. We then assessed how the pair has fared, on aggregate, versus the relevant market in 2022, 2023 and so far in 2024, as well as looking at their cumulative performance over one, three and five years. The findings are evidence that navigating concentrated markets can still be tricky, at least over shorter time periods.

A world of pain

We have kept the same pairings from our previous analysis, meaning that Fundsmith Equity (GB00B41YBW71) and Schroder Global Recovery (GB00BYRJXL91) serve as our two global active picks. Terry Smith’s flagship fund has had some high-profile ups and downs, making a loss of nearly 14 per cent in 2022 only to recover more recently while still lagging some of the big gains made by the MSCI World index. Nonetheless, the fund is a notable backer of some well-known market winners, from Europe’s Novo Nordisk (DK:NOVO.B) to tech majors Microsoft (US:MSFT) and Meta (US:META). Its quality growth style, however, can translate into a focus on resilient cash flows and robust business models, meaning it will lack exposure to economically sensitive sectors such as energy while also running the risk of being less exposed to racy growth stocks than some other funds.

Schroder Global Recovery, which is known as a deep value fund, should help to fill some of these gaps. It has some exposure to energy and basic materials stocks, as well as around 16 per cent of its assets in financials. The fund is much less focused on US equities than many of its peers, with the market accounting for less than 40 per cent of the portfolio, and has allocations of more than 10 per cent apiece to emerging markets, the UK, Japan and Europe.

Complimentary as the two funds might be, they have struggled to weather the memorable recent ups and downs for the MSCI World index, marked as it is by substantial exposure to the US tech stocks that suffered so badly in 2022 and recovered so fiercely last year. Fundsmith Equity’s hefty 2022 loss was only minimally offset by a 1.6 per cent gain for the Schroders fund. Both funds did well in 2023, with Fundsmith returning 12.4 per cent and Schroder Global Recovery making nearly 14 per cent, but both lagged the even stronger performance of MSCI World. A portfolio allocated half to one fund and half to another would, therefore, have fallen behind, if only by a few percentage points.

This is arguably better news than some might have suspected: the Schroders fund did well in a year dominated by classic growth stocks, and in general these two funds can perform well without having as much of the concentration risk that currently haunts the MSCI World index. The fund pair does notably lag the index over a five-year timeframe, although that could reverse if big tech goes into reverse.

Local issues

The UK equity market has benefited from its exposure to more cyclical sectors such as energy in recent times, with the FTSE 100 holding up well in 2022 and both that and the FTSE All-Share making decent returns in 2023, even if these returns notably lagged behind the US and global indices.

Our fund pairing, of Liontrust Special Situations (GB00BG0J2688) and Schroder Recovery (GB00B3VVG600), has had mixed results thanks to a painful 2022 for the former, when it lost around 11 per cent. The Liontrust fund has been exposed to some tough conditions in two respects, with its quality growth style out of favour and the small and mid-cap shares it tends to back also struggling. Schroder Recovery’s performance was relatively flat in 2022 but it made a sizeable 13.1 per cent gain last year.

That translates into a mixed showing, with the pair losing more than both the FTSE 100 and All-Share in 2022 but outperforming last year. Investors might hope, however, that the Liontrust fund’s exposure to the FTSE 250 (30 per cent of assets) and Aim shares (23.4 per cent) might help spur some form of recovery.

The news is brighter for our European fund pairing of BlackRock European Dynamic (GB00BCZRNN30), a flexibly managed fund that has tended to back stocks with structural growth stories, and Schroder European Recovery (GB0007221772).

A 50/50 investment into these two would have suffered less badly than the FTSE Europe ex-UK index in 2022 and made even more money in 2023 as the market bounced back. This is partly a reflection of the fortunes of BlackRock European Dynamic, which made a painful loss of nearly 20 per cent in 2022 but returned 17.5 per cent in 2023.

The fund has a big position in Novo Nordisk, with names such as LVMH (FR:LVMH), Linde (US:LIN) and ASML (NL:ASML) also featuring as prominent holdings. Schroder European Recovery, which returned 6.6 per cent in 2022 and 13.7 per cent in 2023, has very different top holdings, including Sanofi (FR:SAN) and Orange (FR:ORA), and big weightings to the consumer discretionary, financials and industrials sectors.