Background

Last year was a shocker for active managers. Nine out of ten of them failed to beat their benchmarks according to the annual S&P Dow Jones review of active management.

Fund managers are an elitist bunch, however, and many of them are experts on things; perhaps it is no surprise then that so many were wrong-footed in their view that a body-blow to the world’s largest trading bloc and the appointment of a reality television star with no political experience as the president of the United States might be potentially bad for the direction of global economic travel.

As we know everything has worked out very well – so far anyway – and anybody who thinks that this might not last is a treacherous whinging leftie who despises the common man.

Some (metropolitan fops, obviously) might argue that a retrospective annual survey which ignores what is going on in the world and simply looks at short-term numbers as if they prove anything serves little purpose, and they might be right – if that means in terms of providing useful information – but this survey was widely covered, as it is every year, and so from the perspective of the marketing department at S&P Dow Jones it served its purpose very well.

Interested in the longer-term picture, we examined the statistics for ten open and closed-end fund sectors last month and found that, in fact, last year was the worst year for active management this century (all 17 years of it). Looking at those years, though, we found that more than half of active managers had – on average – beaten their respective indices over the period, and more than half did so in 12 of the 17 discrete years.

Active management certainy has its merits then, but the subject of whether active management is ‘better’ or ‘worse’ than passive investing is the editorial equivalent of Old Faithful. It goes off, regular as clockwork, and provides a pleasing spectacle that draws the crowds.

As Charles Plowden, joint senior partner at Baillie Gifford, put it in his open letter to the Financial Times last year – studies based on the median performance of all active managers are interesting but essentially pointless and, as he told Investment Week, it’s down to the individual to make their own case.

Many have – even before they pick these studies up. Those who believe in active management would argue that a decision made with the future in mind will, if made wisely, make more sense than a decision which only considers the present (i.e. to own what’s in the index today).

Fans of active management would also argue that – as in life more broadly – there is a difference (ignored by the statistics) between the mediocre abilities of the majority and the talented few.

Finding them, of course, is the tricky part.

Methodology

Using Jensen’s Alpha we are able to pinpoint those managers who the statistics show have added real value to perforance – producing results which aren’t merely piggy-backing off the market, and we have compared the ability of managers running investment trusts to generate alpha with that of managers running open-ended funds. Jensen’s Alpha shows how much value a manager’s decisions have added to a fund’s performance and a positive score shows the fund manager has beaten the market via stockpicking skills. Theoretically, the higher the Jensen’s Alpha, the better the stockpicking.

We have broken down our findings into regions and sectors including:

• UK large caps
• Global large caps
• European equities
• Asia & Emerging Markets equities
• Smaller companies (including UK, US, European and Global options)

To ensure our analysis is rigorous, we ensure that all of the trusts and funds we are examining have a correlation (as measured by R-squared, a statistical measure that represents the percentage of a fund’s movements that can be explained by the movements of a benchmark) in excess of 0.5% to the index against which alpha is being measured. We ignore any who can’t show this (as it would suggest the benchmark used to calculate the Jensen’s Alpha is wrong for the fund) and prefer 0.7 upwards as this shows real correlation.

We also look at beta. Clearly high or low beta (sensitivity to the index) is neither a good thing nor a bad thing, but a lower beta is important because it suggests the performance of the fund really is driven by the manager, not the market, given the lack of sensitivity to it that this represents.

Our aim is to identify funds that have offered well-managed exposure to each of the regions and sectors under our spotlight.

UK LARGE CAPS: TOP 5 TRUSTS BY ALPHA

Source: Morningstar

Fidelity Special Values comes top in the UK large-cap sectors over five years to the end of March 2017, according to our analysis, delivering annualised alpha over five years of 7.32%. The trust is a multi-cap contrarian play however, and the manager looks for stocks which he thinks are undervalued by the market and due for recovery, so it doesn’t quite fit the bill for a generic ‘UK large cap’ play – but you can read our profile of the trust here.

Likewise Finsbury Growth & Income has produced stonking alpha (7.32% p.a. over five years) under Nick Train, whose CF Lindsell Train UK Equity fund is also top of the pops on the open-ended side with an alpha of 7.74%, however Nick famously only buys a stock once in a blue moon and his idiosyncratic style and tightly focused portfolio makes this a highly specialised personality play.

Instead we highlight Perpetual Income & Growth Investment Trust, managed by Mark Barnett, which offers exposure to large-cap UK equities via a highly experienced manager with a proven style. As we show in our profile of the trust it is differentiated from its big sister, Edinburgh IT, by a slightly more flexible and punchier remit.

GLOBAL EQUITIES: TOP 5 TRUSTS BY ALPHA

Source: Morningstar

In the global sector we highlight Scottish Mortgage Investment Trust which is one of the few investment trusts to have delivered positive annualised alpha (1.24%) over five years in the AIC Global or Global Equity Income sectors and the only large cap fund to have done so.

EUROPEAN EQUITIES: TOP 5 TRUSTS BY ALPHA

Source: Morningstar

In Europe, we highlight JPMorgan European Income Pool(JETI) which has delivered solid alpha over five years, putting it at the top of the sector behind only Alexander Darwall’s Jupiter European Opportunities juggernaut. Alexander’s fund is also top of the open-ended funds in the region but unlike JETI it runs on a ‘Europe including UK’ basis, which makes it less of a ‘fit’ for our purposes in this study where we are seeking a pure European equities play.

By contrast JETI, via a portfolio solely comprised of continental European companies, has delivered a solid performance over one, three and five years, with comparable alpha to JEO, and offers a chunky yield.

SMALLER COMPANIES (UK & OVERSEAS): TOP 5 TRUSTS BY ALPHA

Source: Morningstar

Initially we considered looking at UK smaller companies on their own but, given that we already have a ‘pure UK’ play and also given our weird old-fashioned views about globalisation being a good thing (or at least not necessarily a bad thing) we thought that the distinction between UK and global smaller companies was unnecessary.

Instead we looked at smaller companies funds investing in the UK, Europe, America, Asia and Japan and found some interesting results. What stands out most is how hard it is to add alpha for a smaller companies manager – the average trust across the smaller companies sectors has managed to generate alpha of just 0.54% per annum over five years and the average open-ended fund is actually in negative territory at -1.54%.

Our study highlights Baillie Gifford Shin Nippon which has generated an annualised alpha of 8.5% over five years via a tech heavy portfolio of Japanese smaller companies, managed by one of the largest and longest established teams in the region. We also highlight J.P.Morgan US Smaller Companies, which we last profiled in February, as a stand-out performer in alpha terms (3.27% annualised).

ASIA & EMERGING MARKETS: TOP 5 TRUSTS BY ALPHA

Source: Morningstar

While Pacific Assets offers broad exposure to emerging markets and is managed by an experienced team at Stewart Investors, an interesting play on this theme – and the most important country in it by many investors’ estimations – is Fidelity China Special Situation. The trust has generated more alpha than anything else we’ve come across in this study – open or closed-ended – well ahead of its nearest closed-end rival (India Capital Growth) and more than double its nearest rival in the open-ended Emerging Markets sector (Templeton Emerging Markets Smaller Companies).

BlackRock Emerging Europe, which we profiled earlier this year, is another interesting option particularly for those who think the prospects for Russia are improving – given its large exposure to the country.