Following a lacklustre 2016, active funds have rebounded this year and the bulk of those in popular sectors such as IA UK All Companies and IA Global are ahead of the market over 2017 to date. 
Active funds were beset by a number of challenges in 2016 – a year that saw surprises such as the UK voting to leave the EU and Donald Trump elected as US president – which led to widespread underperformance against benchmarks.
FE Analytics shows the average fund in the IA UK All Companies sector made a 10.82 per cent total return last year while the FSTE All Share was up 16.75 per cent; what’s more, 82 per cent of the peer group’s members posted a lower return than the index over the 12-month period. A similar trend was seen in many other sectors.
Adrian Lowcock (pictured), investment director at Architas, said: “2016 was a difficult year for active investors. The sell-off at the start of the year was replaced by a strong rally and rebound in areas unpopular with professional investors.
“Trash rallies often leave professional investors in their wake as more often than not the fund managers don’t like the risks associated with these types of investments. The developed market also saw a bit of this with a rally in value stocks which came quickly. However, here there was a greater argument as the discount to growth companies had grown very wide indeed.
“In 2016 the markets also had to deal with the Brexit vote and possibly the most bitter US presidential election in living memory. Even if you had got the results right few would have been able to predict how markets reacted, particularly following Trump’s victory. The market barely fell and recovered quickly leading to the rotation into value stocks as investors took the incoming president at his word.”
Source: FE Analytics
However, things have turned around this year. The above table shows the percentage of funds in the major equity sector that are ahead of the index over the year to date, along with the percentage that outperformed in 2016.
Lowcock agrees that 2017 has been far easier for active managers to navigate than the previous year. “With Europe aside, there was little to distract investors who could focus on fundamentals and the global economy has been stronger than it had been for years with almost all markets contributing positively to global growth. Whilst asset allocators might have been chasing the rotation into value that happened at the tail end of 2016 fund managers stuck to their principles and processes, benefitting when the rotation ran out of steam,” he added.
“Even the political elections in Europe failed to cause disruption as the results fell on the side of the status quo and a stronger, more united Europe. This was supported by a resurgent European economy and better corporate earnings. The stronger global economy has been reinforced by better corporate earnings growth and quality companies have risen to the top.
“2017 hasn’t had much to spook it: no China crisis, no eurozone crisis or deflationary concerns. Commodities, and oil in particular have been very stable – within a range. Markets have gotten more used to Trump’s erratic tweets, which occasionally send shivers through markets, and have adjusted their outlook that Trump is increasingly unlikely to achieve much in his four years in office.”
Some of the biggest jump in outperformance percentages have come from the IA Global, IA UK All Companies and IA UK Equity Income sectors. The average fund in each of these peer groups is ahead of the index by a slim margin year to date.
Performance of sectors vs indices over 2017
Source: FE Analytics
In the IA Global sector, the top performing funds are Aubrey Global Conviction (up 33.38 per cent), Morgan Stanley Global Opportunity (29.76 per cent), Standard Life Investments Global Smaller Companies (21.53 per cent), Lindsell Train Global Equity (20.25 per cent) and LO Emerging High Conviction (19.86 per cent).
The IA UK All Companies sector is topped by Old Mutual UK Dynamic Equity (up 26.87 per cent), Elite Webb Capital Smaller Companies Income & Growth (25.24 per cent), MI Chelverton UK Equity Growth (22.69 per cent), Old Mutual UK Mid Cap (22.51 per cent) and MFM Bowland (22.49 per cent).
Man GLG UK Income (up 19.10 per cent), MI Chelverton UK Equity Income (16.37 per cent), Unicorn UK Income (16.06 per cent), TB Saracen UK Income (13.79 per cent) and Unicorn UK Ethical Income (13.74 per cent) are leading the IA UK Equity Income sector over 2017 to date.
Lowcock attributes this turnaround in performance to the speedy demise of the value trade, which took many managers by surprise in 2016 owing to their growth bias. “The rotation from growth to value stocks faded pretty fast, whilst fund managers maintained their focus on the defensive growth areas and didn’t chase the trend as much as asset allocators. So, what didn’t work in 2016 has worked pretty well in 2017,” he said.
“In the UK, Brexit continues to have an effect and the weak pound does so, as well. UK equity income, which suffered from the rotation into value, also benefitted from the rebound whilst a focus on global businesses has helped UK funds to perform. Although there are many managers who see value in the domestic stocks, this has been overshadowed by the snap general election, disappointing result for the Conservatives and the start of Brexit negotiations.”
When it comes to the IA Global Emerging Markets, IA Japan and IA North America only half or fewer of funds are outperforming their index over the year to date. This is either the same or worse than the numbers for 2016.
Lowcock says there are differing forces at play here that investors should be aware of.
Within global emerging markets (GEM), half of funds are beating the MSCI Emerging Markets index – the same result as last year. While performance last year was driven by rallies in heavily discounted areas like Brazil and Russia, this year’s story has been a more stable one as global economic growth bolsters investor sentiment.
“Emerging markets funds are mixed bag of country specific funds and style bias which can lead to strong periods of performance,” the investment director said. “Investors should look for solid long-term track records amongst managers as many GEM funds don’t deliver longer term.
The US has a more clear-cut story: the rise of passive investment and its impact on the market is making it more difficult for active managers to outperform.
“Last year it was a bit easier as the active manager could react to Trump’s election and buy the sectors expected to benefit. However, in 2017 that rotation ended and markets have focused on the FANGs [Facebook, Amazon, Netflix and Google],” he said.
“The dominance of these stocks is huge and the impact on the market performance has been significant. The trouble for active managers at the current valuations it is hard for them to buy these stocks, as some are priced to perfection whilst others are more a reminder of the dotcom era. Active managers tend to avoid overvalued stocks as the long-term returns are never as good. In the short term though this hurts performance, whilst the growth in passives will continue to drive demand for such stocks irrespective of valuations.”
When it comes to Japan, the drop in outperformance is down to the fact the country has been a more complex area to invest in over 2017. Investors are less enamoured with prime minister Shinzo Abe now he is more focused on social policy rather than economic and structural reform.
“Much of the market performance has been in Japan’s volatile and risky smaller companies. This is an area outside of the Topix and also many fund managers’ mandates as they look at Japan’s largest companies. This trend was already in place in 2016 which reflects the fact that the drop in active outperformance is not huge,” Lowcock concluded.