By Ruth Alexander Outperforming UK funds are taking aggressive bets against the FTSE All-Share, incl...
By Ruth Alexander
Outperforming UK funds are taking aggressive bets against the FTSE All-Share, including massively underweighting stocks such as Vodafone and BP.
The top fund in the UK All Companies sector over one year to 11 October has no holdings in the UK's largest company, Vodafone, which makes up 9.76% of the FTSE All-Share index.
Other top performing funds have weightings ranging between 2.2% and 8.3% in Vodafone with only one out of the top five funds, listing Vodafone in its top 10 holdings.
Robin Stoakley, client services director at Schroders, said: "These days, the funds that reach the top of the sector performance table, over the short term, are those that are very aggressive and that are taking big risks.
"In general terms, one wants to outperform the index, but not be at risk of drastically underperforming it.
"Whether you have holdings in the FTSE All-Share top 10 depends on how much risk your fund is designed to take."
As the concentration in the FTSE continues to build, some fund managers are deeming it too risky to stray far from the index weightings. However, others view a close to 10% holding in just one company as too great of a risk to take.
At the moment the top 10 stocks in the FTSE All-Share amount to some 40% of the entire index, with the top two alone adding up to almost 18%. Vodafone's weight-ing is such that if it was to fall its impact on the market would be dramatic.
Over the past five years to the end of September, Vodafone has returned 418%, compared to the FTSE All-Share returns of 74.69%. Over the year to 20 October, Vodafone has returned 3.2%, compared to the FTSE All-Share index, which has returned 10.43%. Over the past three quarters, Vodafone has fallen 9.81%.
At the same time the top performing fund over one year, Solus UK Special Situations fund, has returned 124%, followed by offer to bid returns of 66.3% by Norwich UK Growth and 59.7% by ABN Amro UK Growth. HL UK Performance, ranked fourth over one year, returned 51.7% and Artemis UK Growth returned 48.6% and is ranked fifth. Vodafone is in Norwich Union's top 10 holdings.
Anne McMeehan, communications director at Autif, said: "If Vodafone were to fall substantially it would have a colossal effect on those funds which have a neutral weighting. Furthermore, a fall would impact the whole market place."
Stoakley added: "If Vodafone were to fall by half, it would have a significant effect on the market, as it would bring it down by around 5%. This is a fundamental fall affected by only one stock." He said it is a matter of a fund's objective to determine whether it is riskier to be within the concentrated index or outside of it.
He said: "If a fund is aiming to outperform its benchmark by 2%, then it is a risk to avoid the concentration of the index. However, if a fund has no benchmark and its aim is absolute total return, it may be a risk to adhere to the index's concentrated top 10."
The concentration of the index is not likely to resolve itself any time soon. The forthcoming merger between Glaxo Wellcome and SmithKline Beecham will add another mega group to the top of the index, pushing a third company close to the 10% weighting mark.
McMeehan said it is possible that the concentration of the market is leading to a greater diversification between smaller more aggressive funds and large funds, which tend to adhere to the index to a greater level.
Of the top five one year performers, only one fund is over £300m, with the remainder between £33.4m and £203m. The UK All Companies average fund size is £277.5m. All of the top one year performers have well above average volatility scores.
The £33.4m Solus UK Special Situations fund, ranked first, has a volatility rating by Standard & Poor's of 8.8%, compared to the UK All Companies average of 4.7%. The £203m Norwich Union fund ranked second over one year and has a volatility rating of 6.7%, ABN Amro's UK Growth has a mark of 6.9%, the £40.8m HL UK Performance A fund has a volatility mark of 6%.
The divergence of large, mainstream and small niche funds has been building over the past year. In 2000 there has been a number of investment houses launching sector based, thematic or style-based funds in order to fill in as satellite options within an overall portfolio.
Stoakley said: "There are more funds now that are targeted to take an aggressive approach. There have been few recent launches of conservative benchmarked funds. There has been an increasing volume of specialist funds on the market."
He said this change also has to do with greater competition within the industry, the increasing sophistication of investors and pressure on active fund managers to demonstrate that their funds are not closet index trackers. Alaric Gordon, marketing manager at Solus, said the Solus Special Situation Fund is not benchmarked and the fund manager, Nigel Thomas, has a flexible investment mandate and is not limited by market cap, sectors or sector deviation.
Gordon said this flexible approach allows the fund to stray away from the FTSE All-Share's largest holdings, and look for special investment situations instead.
Gordon said the fund, which has grown from £5m to £40m over the past year, is managed on a much more aggressive basis than Thomas' ABN Amro UK Growth fund.
Thomas' third ranking ABN Amro UK Growth Fund has also grown substantially over the past year and has an aggressive approach to UK stocks.
George Luckraft, a member of ABN Amro's UK desk and Thomas' colleague for 20 years, said that in steering the fund away from the FTSE All-Share's largest companies, Thomas is taking a risk, but also seeking out an opportunity.
He said: "Nigel has the ability to take these views and add value. As the market becomes more indexed, it becomes more inefficient. This leads to an increase in opportunity for stock pickers suc
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