The average active FTSE 250 manager has been more dependent on the performance of the mid-cap index for its returns over the last five years than the average FTSE All Share-benchmarked manager has been relative to its respective index, data from FE Analytics shows.
However, as we explore throughout the rest of the article, there is far more to these results than meets the eye.
The FTSE 250 index recently celebrated 25th birthday. Indeed, since 12 October 1992, it has outperformed its blue-chip FTSE 100 counterpart more than two and-a-half times over with a total return of 1,675.49 per cent.
Reasons that have been cited for this performance gap include the fact it is a less-researched area of the market, and that smaller companies have greater scope for growth.
As such, it is perhaps unsurprising that the average actively-managed FTSE 250-benchmarked fund in the IA UK All Companies sector has outperformed the average actively-managed FTSE All Share-benchmarked fund in the same sector over five years, as shown in the two peer group composites below. For reference, only actively-managed funds with at least five-year track records were included.
Performance of peer group composites over 5yrs
Source: FE Analytics
When delving deeper into these figures, the average active FTSE 250 fund outperformed its benchmark by 27.79 percentage points with a total return of 121.49 per cent. This is a 29.7 per cent increase in value relative to the FTSE 250 index.
In contrast, the average actively-managed FTSE All Share fund outperformed the index by 11.95 percentage points with a total return of 74.03 per cent. This is a 19.2 per cent increase in returns and, as such, the average FTSE 250 manager has generated 35 per cent more outperformance relative to its benchmark than the average FTSE All Share manager within the IA UK All Companies sector has.
While it would therefore be easy to assume the average active mid-cap manager has been better at generating returns outside of its benchmark, further digging suggests this may not be the case.
Upon initial inspection, the FTSE All Share composite’s information ratio (which assesses the degree to which a manager uses skill and knowledge to enhance the fund returns) is indeed lower and its Jensen’s alpha (which is a risk-adjusted measure used to gauge a manager’s ability to add value to the benchmark) is higher.
This is perhaps unsurprising, given that the average FTSE All Share-benchmarked active manager has fared better than their mid-cap peers at protecting investors on the downside over the last five years (as shown by the composite’s lower maximum drawdown – which measures the most money lost if bought and sold at the worst possible times – and downside risk ratio – which measures susceptibility to lose money during falling markets).
What may surprise investors is that the average active FTSE 250 fund has a lower tracking error compared to its benchmark as well as a higher r-squared ratio (which indicates how closely-correlated a fund is to its benchmark) compared to the average active FTSE All Share-benchmarked fund.
Does this mean that multi-cap managers have been better at stock-picking and generating returns outside of the benchmark than their mid-cap peers over the last five years?
Charles Younes (pictured), research manager at FE, said he was surprised at the results of the study. Upon closer inspection, he found that there were a small handful of “big outliers” within the FTSE All Share composite which have significantly high tracking errors relative to the index. 
“In the FTSE All Share [composite], one of the funds with the highest tracking errors is SVM UK Growth and manager Margaret Lawson only buys mid caps, for instance,” he explained. “These funds are very concentrated too so they have very little to do with the FTSE All Share.
“Again, you have just a few very strong outliners when it comes to alpha generation.”
After comparing the relative average returns of both portfolio composites and the FTSE 250 index to the FTSE All Share, he found that the active All Share managers have only outperformed when the FTSE 250 index has also outperformed the FTSE All Share.
Relative performance of indices vs FTSE All Share over 5yrs
Source: FE Analytics
As discussed in an article published earlier this year, he therefore believes that the average FTSE All Share managers’ ability to generate returns outside of the benchmark is more to do with being biased towards mid caps as opposed to stock selection.
“What I really believe is that most of the outperformance of your average All Share active manager is explained by a size bias compared to the FTSE All Share, as they dig into the mid- and small-cap space. In contrast, the FTSE 250 stays within mid caps,” Younes reasoned.
“So, most of the outperformance is not about stock-picking, it’s because they have a high allocation to mid cap which, luckily for them, has outperformed the FTSE All Share over the last five years.”
What is also interesting, according to the research manager, is that the average UK mid-cap manager has improved their performance relative to their benchmark exponentially over the last year while the FTSE 250 has remained flat.
“You could suggest that this is because most of the mid-cap managers were brave enough to hold their positions after the EU referendum results. However, the FTSE 250 hasn’t rebounded quite as well. In which case, this is likely to be down to pure stock picking,” he said.
When delving under the bonnet of the FTSE 250 portfolio composite, Younes pointed out that there is significant disparity between each of the 10 funds.
For instance, Old Mutual UK Dynamic Equity, Old Mutual UK Mid Cap and Old Mutual Equity 1 – all of which are run by FE Alpha Manager Richard Watts – have generated significantly higher relative returns and boast the highest information ratios relative to the benchmark.
Younes said: “Three funds are accounting for a majority of this outperformance and they are all Old Mutual. Only one fund in the composite has a negative relative return – Aberdeen UK Mid Cap Equity - but three have significantly bolstered the market area’s returns.
Performance of funds vs composite and benchmark over 5yrs
Source: FE Analytics
“In terms of tracking error, these three funds have taken a lot of risk. They are tracking the FTSE 250 but they are really, really active.
“In terms of beta [which measures a fund’s sensitivity to benchmark volatility], every fund in the portfolio has been more aggressive than the benchmark apart from benchmark but they all failed to protect from the downside, even Aberdeen.
“Old Mutual is really the only one doing well in the FTSE 250 space.”