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Success of UK active fund managers dependent on continued out performance by UK SMEs

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Over 100 per cent of out-performance of UK equity funds over the last five years to the end of June 2015, was due to a bias to small and medium sized stocks, within the UK All Companies sector, according to new research by SCM Direct.com.

These funds typically had just 53 per cent invested in the largest UK companies which represent 70 per cent by value of the UK stock market. They typically invested 47 per cent of their funds in smaller/medium sized companies that together represent 30 per cent by value of the UK stock market.
 
The performance of the ‘actively managed’ largest fund sector, the GBP168 Bn UK All Companies sector, was found to closely follow an investment of 55 per cent in a FTSE 100 tracker, and 45 per cent in a FTSE 250 tracker over the last five years to end June 2015.
 
Eighty five per cent of out-performance of UK equity income funds over the last five years to end June 2015, was due to the same inherent size bias within the UK Equity Income sector. These funds had just 59 per cent invested in the largest UK companies which represent 70 per cent of the stock market by value. They typically invested 41 per cent of their funds in smaller/medium sized companies that together represent 30 per cent by value of the UK stock market.
 
Only 2 per cent of the funds analysed (4 out of 179 funds) beat the market five years running, once adjusted for the inherent size bias of each fund.
 
The last few years have witnessed significant outperformance of the UK equity market by active funds. SCM Direct‘s research sought to test whether this was simply a result of the inherent bias of active funds to have less in large companies and more in smaller/medium sized companies. 
 
SCM Direct analysed all funds within the UK All Companies and UK Equity Income sectors, reviewing monthly data, where available, regarding the percentages invested in large caps, mid-caps and small caps. The average yearly exposure based on monthly data was calculated, to see what return would have been produced had their exposures to small cap, mid cap and large cap simply performed in line with the average similar sized company in each size segment.
 
SCM Direct.com conducted a further in depth study of 179 UK retail active  funds in these two popular sectors with a five year track record; the combined assets of these funds was GBP122 billion. They found that when you strip out the effects of this inherent bias to small and medium sized companies, the outperformance for UK All Companies Funds disappeared entirely and nearly disappears for UK Income funds.
 
Only four funds in the sample managed to beat the market cap adjusted returns of their fund, in the 5 years.
 
Gina Miller (pictured), co-founder of SCM Direct, says: ‘Our research is yet another nail in the coffin of the majority of active funds. Simply buying a combination of a FTSE 100 tracker with a FTSE 250 tracker, closely resembles the performance of a typical actively managed UK equities fund, whilst saving over 80 per cent of the annual cost (based on a typical tracker charging c. 0.15 per cent pa Ongoing Charge vs a typical UK active fund charging c. 0.85 per cent pa Ongoing Charge).
 
‘Following the outperformance of small and mid-cap stocks, many of these stocks now command a premium valuation, compared to their larger peers. This may negatively impact the future returns of many active funds in these two major sectors.’

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