- We look for smaller funds with high levels of risk-adjusted outperformance
- The latest selection covers US value, Asian small caps and much more
Active funds have not been doing well lately. AJ Bell’s research found that just 30 percent of active open-ended funds from major sectors outperformed the relevant market tracker in the first half of 2022, while Columbia Threadneedle’s analysis shows consistent top performers have become amazingly rare.
As bleak as these findings are, there are still active portfolios that have comfortably beaten passive rivals on a variety of time frames. And while there are many ways to judge a good active fund, one compelling argument is that they offer the most potential even though they are relatively small in size: run by an investment team eager to succeed and, more importantly, free from the risk that managing large sums of money forces them to adapt their investment preferences.
This is where our annual list of small and overlooked equity funds comes in. Continuing a series that began in 2019, we examined the fund universe for small portfolios that produce impressive risk-adjusted outperformance. Our process is explained in the “methodology” section of this article.
Okay funds in bad markets?
Historically, we have highlighted 10 funds from major equity regions that have produced a superior annualized level of risk-adjusted outperformance over a three-year period, while also verifying that these portfolios are available in at least some of the major retail platforms. The task has been more difficult than usual this year: the volatility observed in the last 12 months has reduced the number of eligible funds and, in addition, some of the names identified by our process this year are not available to retail investors.
As a result, only eight funds appear on our 2022 list, and it’s notable that not a single global growth fund meets the criteria. No funds from the UK Investment Association (IA) All Companies sector also appear on this year’s list. Therefore, it is other regional stock offerings that have taken over. And while many funds on our list inevitably have paper losses over the past year, they still meet the right criteria during our three-year evaluation period.
Asia has provided two best results, one of which is especially familiar: Matthews Asian Small Businesses (LU0871674379) makes its fourth appearance in a row, having continued to generate strong returns but yet to reach a size that would exclude it from our analysis.
The investment team likes companies with a competitive advantage, whether it be pricing power, distribution capabilities, or differentiated technologies or services, and businesses with an innovative streak. The investment process also plays into one of the main attractions of this particular equity region, favoring companies that cater to growing domestic consumer demand.
The fund had 60 holdings at the end of July, with 41.9 percent of the portfolio tied up in the top 10 holdings. China and Hong Kong accounted for almost 30 per cent of the fund, as did India, with the team noting that stock selection in the latter helped performance in the first half of 2022. If the focus on competitive advantage makes the fund looks much like many other quality growth portfolios, the team emphasized in a mid-year update that it “seeks to maintain a balance between growth and value exposure while remaining broadly diversified across sectors and countries in the region”.
|Best Small Funds Funds of 2022|
|Sector||Background||Three-year annualized information ratio versus benchmark||Size (millions of pounds sterling)||Continuous charge (%)|
|Asia||Jupiter’s Pacific Equity||0.79||47.3||1.2|
|Asia||Matthews Asian Small Businesses||0.52||75.7||1|
|Emerging markets||Carmignac Emerging Markets||0.73||21.1||0.95|
|Europe||SVM Continental Europe||1.16||49.3||1.16|
|Europe||Invesco’s European approach||0.81||32.5||1.1|
|Japan||Janus Henderson Japan Opportunities||0.43||29.8||0.86|
|U.S||Clearbridge US Value||0.52||37.2||0.99|
|Smaller UK companies||Teviot UK Smaller Companies||1.2||72.2||0.85|
|Source: FE Analytics and funder literature|
It is worth noting that the fund’s lead manager, Vivek Tanneeru, has only been in the role since the summer of 2020 and thus cannot claim the full three years of outperformance. But the fact that this fund has so consistently ticked the right boxes suggests a strong investment process that justifies its place on the list.
Asia and emerging markets may offer a fairly mixed return for investors, but fans of these regions as a game of solid demographics may also get excited about Carmignac Emerging Markets (GB00BK1W2P36), which seeks to benefit from the “dynamism and growth potential” of its investment universe. Unlike the Matthews Asia fund, it tends to target large- and mid-cap stocks and, like other funds in this space, has large positions in certain stocks that rank high in the underlying market, with Samsung Electronics (KR:005930) Y Taiwan Semiconductors (TAI:2330) representing nearly 15 percent of the portfolio at the end of August. The team claims to look for cash-generating businesses in underpenetrated sectors, and an allocation of nearly 30 percent to consumer discretionary stocks suggests the focus on the aforementioned demographics.
Europe may be a troubled region, but active funds fishing in its markets can still significantly outperform, as the inclusion of two portfolios from the region shows. However, one comes with a mixed history. SVM Continental Europe (GB0032094954), another fund that made last year’s list, has fallen sharply in the past 12 months, but posted huge gains before then. It had about half its assets in mid-cap stocks at the end of July, a bias that may well explain some of the recent painful performance. Invesco European Focus (GB00B8N44N55) it has looked steadier, taking a modest hit in the last year and also making big gains before market volatility set in.
We expanded the range of sectors we evaluated this time, and the Investment Association’s selection of the smaller company sectors led to the inclusion of Teviot UK Smaller Businesses (GB00BF6X2124), whose underlying investment process is “based on the basic fundamentals of the company seen through the lens of a value investor.” Recent notable holdings included the power generation business Drax (XRD) and waste management specialist Renew (RWI) – though the fund had only about a fifth of its assets in the top 10 holdings, with a focus on diversification common to many small-cap portfolios.
Value investing is a common theme on this year’s list, a trend that is emphasized more explicitly with the appearance of FTF ClearBridge US Value (GB00B8F2KD97). The fund has fallen in dollar terms so far in 2022, but has fared better than the broader US stock market. It has large sector allocations to financials and health care, but the fund is also poised to support bombed-out stocks that are generally more associated with growth investing: Meta (US: META) it was his largest portfolio holding at the end of July. With the markets going round and round, it remains to be seen whether the opposing managers can continue to stand out through their risk-adjusted returns in the months and years to come.
We are looking for funds with more than £10 million but less than £100 million in assets. The existence of this lower limit is partly due to the increased risk that funds with less than £10m will soon close or merge with other products. Funds above the £100m mark, on the other hand, tend to attract the attention of a few larger investors and can quickly grow in size – in short, their qualities don’t stay hidden for long.
Instead of looking at simple performance numbers, this list looks for funds with high annualized reporting ratios compared to their benchmark over three years. We prefer the information ratio to other metrics because it measures outperformance, but it also accounts for the level of risk a manager has taken to deliver it. A ratio of 0.4 or more tends to indicate a decent level of managerial skill.