Over one, three and five years most active funds failed to beat this passive fund. Kyle Caldwell explains why.
Over the past five years, both domestic and international investors have been ditching the UK market and broadening their horizons by increasing exposure to overseas shares.
Global funds, which have the freedom to invest wherever the fund manager sees fit, have been the big beneficiaries. Data from the Investment Association (IA) shows that for the past four years the sector has been the bestseller among retail investors.
Over the past year, £12 billion has poured into global funds. In contrast, just under £4 billion was withdrawn from funds in the UK All Companies sector.
However, investors needed to have been careful over their fund choice. The sector is a big one, housing a variety of investment strategies, both actively and passively managed. In total, there are close to 500 funds and, as a result, there’s been a wide dispersion in returns. Over five years, for example, returns range from -12.3% to 195%. The average fund over this time period has delivered 58.1% to 23 March, according to FE Analytics.
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Few active funds managed to outsmart a passive fund, which is among the top performers over one, three and five years. That passive fund is L&G Global 100 Index Trust. The table below shows its performance over those three time periods, and highlights how it has comfortably outpaced the average global fund.
How average global fund has fared against L&G Global 100 Index Trust
|Fund||One year||Three year||Five year|
|L&G Global 100 Index Trust||21.5%||65.7%||92.5%|
|Average global fund||7%||40.9%||58.1%|
Source: FE Analytics. Data to 23 March 2022.
Over one year, just two active funds delivered higher returns: Royal London Global Equity Select and Lazard Global Equity Franchise, up 24.3% and 22.3%.
Over three and five years, a greater number of active funds enjoyed success – 14 and 23, respectively, in total. However, in percentage terms, given that there are hundreds of actively managed global funds, this is not a great endorsement for selecting a fund manager over a passive fund that simply follows the movements of an index.
So why has L&G Global 100 Index Trust fared so well? The key reason for the outperformance is the make-up of the S&P 100 index that the L&G Global 100 Index Trust tracks.
The index has significant weightings in the US technology behemoths that have delivered exceptional performance after benefiting from loose monetary policy. The four largest holdings, comprising more than 40% of the passive fund, are Apple (NASDAQ:AAPL),Microsoft (NASDAQ:MSFT), Alphabet (NASDAQ:GOOGL) and Amazon (NASDAQ:AMZN). The respective individual weightings are 13.8%, 12%, 8.3% and 7.2%. The US is heavily represented, accounting for 72.3% of assets.
Gavin Haynes, co-founder of Fairview Investing, points out that “such outperformance of very large index constituents is unusual and questionable whether it can continue”.
He adds: “Active managers are unlikely to take such large positions and investors need to question if they are comfortable with the level of stock-specific risk that exposure to this index tracker provides.”
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Scott Spencer, a fund manager in the multi-manager people team at BMO Global Asset Management, points out that the dominance of big US tech over the past couple of years has made life difficult for stock pickers.
Spencer adds: “Active funds tend to hold less than the index in tech, and there are restrictions on how much they can hold in an individual stock – they cannot hold more than 10%. Given that Apple is nearly 14% of the L&G Global 100 Index Trust, an active fund manager will hold less.
“Most global funds are more diversified than this index tracker, and will therefore not have as much as over 70% in the US.”
Don't write off active funds
Haynes points out that over the past five years around one third of active funds have outperformed the MSCI World Index, which is the common benchmark for funds that invest in global shares.
However, going forward tech is likely to be less dominant given the tightening of monetary policy.
Various growth shares, particularly technology firms, have been hit hard since the start of the year. At the other side of the trade, value shares, which tend to benefit from high inflation and increases in interest rates, have been back in favour with investors.
Tech companies and other growth stocks have come under the cosh due to the value of their future earnings being devalued by higher inflation.
As a result, some global fund managers have been cutting back on their exposure to tech shares, including James Thomson, manager of the Rathbone Global Opportunities fund. In a recent video interview with interactive investor Thomson said the changes to the portfolio were prompted by his view that the one-sided dominance of tech and growth shares is starting to fade.
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The fund’s exposure to tech has been reduced from 29% to 20%, with the proceeds redeployed into areas that will benefit from reflation and the re-opening of economies – including banks.
“We've been buying some banks for the first time in five years - US regional banks that are growing quickly and not just pure plays on the rate cycle.
“We've been buying some sort of picks and shovels, old economy, industrial businesses that will really benefit from this period of high levels of cap-ex as a lot of these industries have underinvested and we're now entering a period of higher-than-normal demand.”
Realistically, any potential ‘great rotation’ towards value is unlikely to go in a straight line. As ever, balance is key. Therefore, it is prudent to mix and match between growth and value strategies. Doing so, will help investors achieve greater levels of diversification in terms of investment style.
Global value funds include Jupiter Global Value Equity, Schroder Global Recovery, Ninety One Global Special Situations and Overstone Global Equity Income. For investment trusts Murray International (LSE:MYI), a member of interactive investor's Super 60, is another option.
Haynes is a fan of Rathbone Global Opportunities. He also picked out Fundsmith Equity and Janus Henderson Global Sustainable Equity as two other active funds that he rates. He points out the trio have outperformed the MSCI World Index over the past five years and proven to be good core holdings.
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Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.