Over the past five and 10 years, most global funds have underperformed the FTSE World Index. Hannah Smith explains why.
Investors can’t seem to get enough of global equity funds right now. The latest Investment Association retail fund sales data shows that the Global sector was the most popular with investors in December, taking in a net £1.2 billion during the month.
But long-term performance of global equity funds has been disappointing – eight out of 10 have failed to keep pace with the FTSE World Index over the last five years, according to research from wealth manager Quilter. And, over a decade, just 18% have managed to outperform the wider market.
The dominance of US tech
What’s behind this long-term underperformance? The key is the US, which has become a much more dominant part of global benchmark indices. In July 2016, around 55% of the FTSE World Index was in North America, notes Ruli Viljoen, head of manager selection at Morningstar UK. By the end of January 2021, it had risen to 60%.
In comparison, the average global equity fund in the Investment Association’s global sector had 47% in North America in 2016 and it had crept up to 56% by 2021. “Over that time, North America has returned 150%, so the fact that they are underweight US has been a massive contributor to underperformance,” says Viljoen.
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An overweight to the struggling UK market has also played an important role. “On the opposite side of the spectrum, if you look at the average UK equity exposure – the average fund in July 2016 had 20% in UK equities compared to the FTSE World which had 8.5%, and today the average global fund has 7% in UK equities and the FTSE World has 4.5%, so still overweight. The UK, in contrast, is only up 24.5% in performance terms, so that’s the biggest thing I think.”
The other big issue has been the relentless outperformance of growth stocks versus value. Viljoen says that, since 2016, growth as a style is up 140%, while value is up 53%, so any fund with a value style bias will have been left behind. And it’s no secret that technology has been the winning sector, and in fact just a handful of FAANG stocks have been the main drivers of outperformance. As these stocks have become a larger part of the index, it has become harder for global fund managers to keep pace because the chances are they will be underweight names such as Apple (NASDAQ:AAPL) and Amazon (NASDAQ:AMZN), and some won’t even hold them at all.
“If you look at the US market, roughly a quarter of that market is now in the big five tech stocks, so the returns that have been driving markets up are just so concentrated in those few stocks,” explains Mike Deverell, investment manager at wealth manager Equilibrium. “It’s very rare that you will find an active equity fund that is overweight those stocks, people tend to be underweight them, and that’s why they have underperformed.”
Quilter’s head of fund research Nick Wood agrees it has been hard for global fund managers, who are expected to be broadly geographically diversified, to justify having two-thirds of their portfolio in the US.
“As a result, these managers have missed out on some of the remarkable gains we saw from the handful of technology companies in the S&P 500 by being underweight,” he says.
Behind the curve
If global fund managers try to catch up by adding to their US positions now, there’s a chance the easy gains will already be behind them, especially if the rotation towards value proves a lasting shift. “For me, the risk now is that they latch on this momentum that’s dominating markets today and they get caught on the way down with positioning,” says Viljoen, pointing to what happened 20 years ago when global fund managers piled into emerging markets just as the tide was turning and ended up getting burned.
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However, she does think that some global managers such as Terry Smith, fund manager of Fundsmith Equity and James Thomson, fund manager of Rathbone Global Opportunities, have a strong enough stock selection process that they will remain disciplined and stick to what they know. This should serve them well over the long term, she suggests.
Global funds will remain popular
Deverell is also confident in the prospects for global funds and, while remaining broadly diversified, he has added some global value funds into client portfolios including Schroder Global Recovery. “It has had a terrible year, but we bought it in November after the vaccine announcement and it’s done really well since then,” he says.
Wood, meanwhile, thinks investors will continue to be drawn to global funds over regional funds, especially with the growing popularity of sustainable and impact funds. He adds: “These tend to have a bias towards a global offering, so it will be interesting if regional funds look to capture some of this market, given superior performance over recent periods.”
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