As 2013 receded, few would have expected a stellar performance this year from the IMA UK Index-linked sector or that active managers would find outperformance so elusive
Regent Street flipped the on switch for their annual Christmas light display on 16 November. The event is always a reminder that the year is about to finish and it is time to reflect on where we have been.
From a fund analyst’s perspective, 2014 was a year full of surprises. At the end of 2013, who could expect that the IMA UK Index-Linked sector would be the second best performing in 2014?
The best-performing sector is North America although the Federal Reserve announced the end of its stimulus measures which could mean a slowdown for the sector’s stellar performance. Many active managers found difficulties in outperforming their benchmark; 2014 being probably one of the worst years on record for active management. Let’s start our review (all data up until 12 November).
Performance for UK equities was flat in 2014, in a typical risk-off/risk-on environment. After a promising start of the year, the severe weather conditions in the US and the Ukrainian crisis put doubt on the global economic recovery, triggering a market sell-off in the first quarter. The risk of a global epidemic of the Ebola virus caused another period of panic in the market in September.
Large-cap stocks (as represented by the FTSE 100 index) outperformed their smaller peers. The market rotation out of growth stocks into large cap and value name, which occurred in April 2014, continued in the summer months. The rotation caught a large number of UK equity managers out since they were heavily invested in medium and smaller companies.
This is the main reason why active managers within the IMA UK All Companies sector have underperformed the FTSE All Share index in 2014. The average fund in the IMA UK All Companies sector is down 0.75 per cent year-to-date. Many fund managers were more exposed to that market rotation, such as Nigel Thomas in the Axa Framlington UK Select Opportunities fund.
Conversely, UK equity income managers did profit from the shift. They typically invest in UK’s largest companies, as those tend to pay higher dividends to their shareholders. GlaxoSmithKline, HSBC, Royal Dutch Shell, BP and Vodafone accounted for 36 per cent of all dividends distributed in 2013.
Average performance for funds within the IMA UK Equity Income was slightly positive (+1.73 per cent). Defensive-value style managers, like FE Alpha Manager Francis Brooke, did especially well in this environment. His Trojan Income fund has returned 7.99 per cent to its unitholders so far this year.
Equity investors have been rewarded for going global in 2014. Double-digit returns could be expected for investing in global equities as the MSCI World index returned 9.95 per cent (in sterling terms) this year.
Meanwhile, despite the end of the quantitative easing program in the US and the strength of dollar, emerging markets also did well, despite underperforming their developed markets peers. Emerging markets equities mainly suffered in the first quarter of the year. Political and macroeconomic events in Russia, China, Turkey and Argentina impacted the asset class.
Nevertheless fund managers in the IMA Global sector on average failed to generate a better return than the MSCI World Index. Average performance for the sector is 5.52 per cent in 2014. This clearly reflects disparities in portfolio amongst global equity managers.
As indicated by data in the table, portfolios with an overweight position in US equities fared well this year. Not only did geographical allocation have an impact, but sector positioning also played a role. Funds which were overweight in healthcare and infrastructure, like the First State Global Listed Infrastructure fund, outperformed their peers in the IMA Global sector.
UK-based investors also had to take into account currency moves. The US economy is recovering at a faster pace than most neighbouring economies. As the Fed is the first central bank expected to raise its interest rate, the dollar has strengthened against other major currencies.
This move further helped UK investors in US equities. On the contrary, yen and euro currency moves were a headwind for UK Investors. Both currencies weakened against the pound sterling, as the Bank of Japan and European Central Bank announced further accommodative policies.
2014 was another year when it was better off staying away from the eurozone for UK investors. On average, investors in IMA Europe (excluding UK) lost 2.7 per cent.
The European equities markets traded with no real direction, as investors could not find any solid evidence of a robust economic recovery. The lack of direction prohibited fund managers like Cedric de Fonclare from outperforming this year. His Jupiter European Special Situations fund ranks in the fourth quartile of the sector with a negative performance of 4.35 per cent.
Surprisingly, the best returns this year were to be found in bond markets, especially from UK government bonds. Despite Mike Carney hinting at a possible rate rise in June, the Bank of England decided to maintain its interest rate level.
The Bank recently announced that the rate rise is unlikely to occur before autumn 2015, driving yields for 10 years UK Gilts further down in 2014. Thus the FTSE Actuaries UK Conventional Gilts All Stocks generated a performance of 9.21 per cent; average return for funds within the IMA UK Gilt sector was 9.41 per cent.
It was worth taking interest rate risk in 2014 as longer-dated UK Gilts outperformed short-dated bonds. For example the passive index tracker Vanguard Long Dated Gilt Index generated a positive return of 16.19 per cent. Additionally inflation risk paid off as inflation-linked UK Gilts also outperformed conventional Gilts. The FTSE Actuaries UK inflation-linked Gilts All Stocks index returned 13.25 per cent this year.
Credit markets generated a positive performance this year. Despite investment grade spreads kept trading far below their historic average levels, the asset class generated sustainable return this year. Long term corporate bonds outperformed with the Iboxx Sterling Corporates 10+ index returning 12.44 per cent. Investment grade bonds outperformed high yield instruments with the ML Sterling High Yield Bond generating just 5.05 per cent this year. Spreads for high yield issuers remain at low levels, which are partly explained by low default rates.
Global bond markets were also in positive territory, despite underperforming sterling-denominated bond markets. For UK investors, an investment in other developed government bonds would have returned a positive performance of 5.32 per cent as indicated by the JP Morgan GBI-EM index.
Emerging market government bonds did slightly better as average performance for funds in the IMA Emerging Markets bonds was 6.56 per cent. As indicated by the Barclays Global Aggregate index, global credit markets were also on positive territory this year.
Many active bond managers failed to capture the trends in 2014. At the end of 2013, many managers were warning investors on rate rise, i.e. that there was high interest rate risk. Thus their portfolios were mainly invested in instruments with low sensitivity to change in interest rates.
Strategic bond managers failed to impress investors this year. IMA Sterling Strategic Bond funds averaged a performance of 5.33 per cent this year. Managers such as Ariel Bezalel were wrong on macro calls as they expected a rise in interest rates and therefore went too low on duration. His Jupiter Strategic Bond fund ranks in the sector’s fourth quartile on a year-to-date basis.
Multi-assets and targeted absolute return
In that difficult environment for active management, mixed investments funds also did poorly. Bearing in mind the outperformance from bond markets, especially UK Gilts, it is not surprising that funds in the IMA Mixed Investments 0-35% Shares sector did slightly better than other mixed investments sectors.
Some managers did outperform their peers by allocating to global equities. Managers such as Mike Fox enjoyed the benefits of an overweight allocation to US equities. His CIS Sustainable World fund leads its sector in terms of performance in 2014 with a return of 9.19 per cent.
Finally it was another difficult year for targeted absolute return funds. Average performance for the sector was 1.98 per cent. Funds in this sector suffered in September and October as prices in bond and equity markets fell simultaneously. As an illustration, the fund loved by many – Standard Life Global Absolute Return Strategies (GARS) fund – lost 2.86 per cent in the first two weeks of October.
Key takeaway In 2014, UK inflation-linked bonds topped the performance tables against all forecasts revealed at the end of 2013. Active managers, on the other hand, have significantly underperformed in what has been one of the worst years on record for active management.
Charles Younes, fund analyst, FE Research