T Bailey

June 2010 - Where has all the alpha gone?

Published 12:00AM 9 June 2010

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Recent times have proved very challenging for fund of funds as the percentage of actively managed funds that have out-performed their respective indices has fallen.  This makes managing a fund of funds harder in that not only is the performance of the average fund further below the index (meaning that the positive contribution from active fund selection needs to be greater in order to beat the index) but also that the number of funds adding value is smaller (thus making it harder to add that value from fund selection).

The chart below illustrates this by looking at the number of equity income funds (the combined IMA UK Equity Income and IMA UK Equity Income & Growth sectors) that have outperformed the FTSE All-Share Index over rolling 12 month periods back to the 12 month period ending 30 June 2000.  As you can see there are times where active management works well and times where active management does not work as well.  Recent times have provided a paucity of funds that have added value.

There are things to notice from the above chart.  Firstly things cannot get much tougher for fund selection and secondly the trend above is not totally cyclical – over the 11 years covered by the above there has been a marked decline in the average success of equity income funds relative to the index which makes their continued popularity even more impressive. 

Although we have chosen a sector where the decline is pronounced, we have noticed for other sectors too a decline in the success of active management for the period from 31 December 2007 onwards.  The only main sector to buck this trend and where the success of active management has improved from that date onwards is the United States where common logic has historically been to use passive investments.  It is no surprise therefore that we have recently introduced a number of active US funds in the T. Bailey Growth Fund. 
As mentioned above things cannot get much harder and the cyclicality of the success rates suggest better times ahead for fund selection and by definition funds of funds.  With the beta-led rally of 2009 behind us and indications that we are moving towards a range-bound market there is every possibility that active management is about to experience better times over the remainder of 2010 and beyond.  The recent record inflows into funds of funds will be well placed to benefit from this.

Submitted by: Jason Britton

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