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Fund size warnings: Which funds are least correlated to sector giants?

A study of 516 UK equity funds by CBS pensions division The Pensions Institute concluded large funds tend to underperform small funds

Fresh warnings have been sounded about giant funds after Cass Business School research showed rising assets under management lead to a fall in performance.

A study of 516 UK equity funds by CBS pensions division The Pensions Institute concluded large funds tend to underperform small funds because their sizeable inflows scale up their existing investments, driving up asset prices and pushing down yields.

David Blake, Tristan Caulfield, Christos Ioannidis and Ian Tonks – the academics behind the research – argue performance tends to fall by nine basis points a year for every 1 per cent increase in assets under management. 

Furthermore, they suggest manager skill is not enough to combat this drag on performance.

“If better-qualified managers do manage the largest funds in the largest fund families – which is entirely plausible – they do not appear to deliver outperformance. In other words, the size of the fund overwhelms any superior skills they might have,” says the study.

A solution suggested by the academics is for funds to split when they reach a certain size. Until this happens, however, investors may want to look outside the larger funds for new ideas or simply find bedfellows with a lower correlation. 

With this in mind, Money Marketing has examined FE Analytics data on the four most popular IMA sectors to identity a number of funds uncorrelated with their largest member.

IMA UK All Companies

Mark Barnett’s £13bn Invesco Perpetual High Income fund is the largest fund in the IMA UK All Companies sector; its assets account for 8.5 per cent of the peer group. Previously managed by equity income veteran Neil Woodford, the fund has become a mainstay of investor portfolios thanks to a healthy total return and a history of avoiding risky parts of the market.

Those wishing to find funds uncorrelated to Invesco Perpetual High Income could look to Mark Slater’s £102.2m MFM Slater Growth fund, which has a correlation of 0.37 over three years, and £32.9m MFM Slater Recovery, which has a 0.39 correlation. Both funds focus on smaller companies and have outperformed the sector over the past five years.

Another small-cap focused option is the £30m Unicorn UK Growth fund, which has a 0.42 correlation with the Invesco fund and is first quartile over one, three and five years. Sadly, one of its managers – John McClure – recently passed away but the fund is managed on a team basis and Fraser Mackersie has been on the portfolio since 2011.

IMA Global

At £8.7bn, Stuart Rhodes’ M&G Global Dividend fund accounts for 12.5 per cent of the IMA Global sector’s assets. Rhodes’ bottom-up stockpicking approach has proven successful and he applies a strict one-in, one-out policy on his 50-stock portfolio.

FE Analytics shows Edward Guinness’s £6.1m Guinness Alternative Energy, Edouard Carmignac’s £4.8bn Carmignac Investissement and Andrew Dalrymple’s £63.6m Aubrey Global Conviction funds have the least correlation with M&G Global Dividend. 

However, all have underperformed the IMA Global average over three years while Guinness Alternative Energy is the only one of the three to outperform over one year.

Richard Bell’s £18.2m Baillie Gifford Phoenix Global Growth, on the other hand, sits in the IMA Global sector’s first quartile over one, three and five years to 18 June. With a correlation of 0.68 with M&G Global Dividend, the fund has more exposure to large growth stocks than Rhodes’ portfolio.

IMA UK Equity Income

Another of Barnett’s funds – the £7.8bn Invesco Perpetual Income fund, formerly managed by Woodford – is the largest in the IMA UK Equity Income sector with a 13 per cent share of its assets. Like Invesco Perpetual High Income, the fund has suffered significant outflows since Woodford’s departure was announced in October last year although it remains one of the best-known funds in the sector.

The least correlated fund in this sector is Peter Webb’s £4.2m Elite Webb Capital Smaller Companies Income & Growth, at just 0.07. However, the fund has a mixed track record – it was the worst performer in the sector during 2011 and 2012 but was the seventh best in 2013 and was the top performer between the start of 2014 and 18 June.

Paul Craig’s £16.6m Henderson UK Strategic Income has a correlation of 0.41 with Invesco Perpetual Income but again has a mixed performance history. It underperformed the sector in 2011 and 2013 but outperformed in 2010 and 2012.

A portfolio with a more solid performance profile is the £676.7m Unicorn UK Income fund, which is managed by Fraser Mackersie and Scott Moon following the death of John McClure. With a correlation of 0.48 to the Invesco fund, it was the best fund in the sector in 2010 and 2012 and the fourth best in 2013 – although it sat in the third quartile in 2011.

IMA £ Corporate Bond

Mark Kiesel’s Pimco GIS Global Investment Grade Credit fund runs 18 per cent of the IMA £ Corporate Bond sector with assets of £9.9bn. It aims to achieve incremental and consistent outperformance of the Barclays Global Aggregate index by investing in corporate bonds and credit instruments that have an investment grade credit rating.

Sebastian MacKay and Daniel McKernan’s £162.8m Standard Life Investments AAA Income, Chris Lynas and Ian Kenny’s £29m Smith & Williamson Fixed Interest and Matthew Russell’s £436.6m M&G Short Dated Corporate Bond funds have the least correlation to it. However, all three have periods of fourth-quartile performance across several recent calendar years.

Howard Cunningham’s £285.8m Newton Long Corporate Bond fund, on the other hand, has a correlation of only 0.66 to the Pimco offering. It sat in the third quartile during 2012 and 2013 but was first quartile in 2010 and 2011. On a cumulative basis, it is first quartile over one, three and five years to 18 June.

Expert view


Rathbone Multi-Asset Portfolios assistant manager Mona Shah

Our process is very much based around balancing return and risk with correlation. An assessment of correlation is key to the assessment of risk. Why? Because no risk measure can exist in isolation because of the impact of correlations.

These effects can change and need to be monitored. 

One example is gold, historically a safe haven, which, towards the end of 2011, showed a positive correlation to equities (we used the FTSE Eurotop as a proxy).

Regarding  fund selection, we need to understand how correlations within sectors are likely to shift over time. To deliver this, our asset buckets – which map liquid, equity and diversifying classes – are based on correlation factors.

So for liquid securities, these asset classes display low or negative correlation to equities and include sovereign bonds and cash. For equities, the bucket includes those asset classes with a high correlation to equity markets.

This does not cover equities alone but all asset classes which are expected to lose value or become illiquid during periods of market distress. They may even offer limited diversification benefits in some market conditions. 

For ‘diversifiers’, however, only asset classes which demonstrate a lack of correlation to equities over market cycles will be included in this classification. 

These include precious metals, non-directional hedge funds and ungeared commercial property. We would expect this part of the strategy to have a correlation below 0.4 to UK equities over the full market cycle.


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