Special situations and recovery funds have outperformed with returns of 59.11% on average over the three years to the end of August
Style bias is proving to be the key determinant of performance in the UK All Companies sector over the three years to the end of August.
During this period, the average fund in the sector has risen 18.84%, offer to bid, while the 74 named growth portfolios have returned 20.4%.
Special situations and recovery funds have on average massively outperformed the sector over three years. The 11 named special situations and recovery funds have delivered an average return of 59.11%, outperforming named growth funds by 38.71%.
A number of growth funds have delivered very strong returns over three years, such as ABN Amro UK Growth, up 96.53%, Marlborough UK Equity Growth, up 90.06%, and Artemis UK Growth, up 73.94%. However, only two of the 74 named growth funds in the sector have produced positive returns over one year ' Invesco Perpetual UK Growth and Marlborough UK Equity Growth, up 5.96% and 9.21% respectively over the 12 months to the end of August.
Consequently, the majority of growth funds have seen the often impressive capital appreciation delivered over the discrete period of September 1999 through to August 2000 eroded over the past 12 months.
Dresdner RCM UK Growth has outperformed over the three years to the end of August, returning 31.29% versus a sector average of 18.84%.
Managed by Neil Dwane, the £165m fund is a bottom-up, research-driven, high risk high return vehicle with a beta of 1.35%, compared to the sector average of 1%. Consequently, the fund has underperformed over the 12 months to the end of August, down 30.65%, compared to a sector average of -16.94%.
Dwane has maintained a growth-oriented portfolio throughout the market downturn. Wary of style drift, he avoided defensive areas such as tobacco, utilities and cash, which have outperformed over the calendar year.
He is now becoming cautiously bullish on certain growth stocks and has tightened his portfolio in the belief that they are now on cheap valuations.
Dwane said: 'The fund has 56 stocks, which is about the middle of our range. We have started to tighten in various names as our conviction in certain areas starts to grow.'
The fund has a multi-cap mandate but is currently overweight mid caps relative to large caps and neutral weight smaller companies, Dwane said.
Sizeable holdings in large caps can be taken, with investment of up to 3% either side of the stock's weighting in the index permitted.
Dwane has maintained an overweight position in pharmaceuticals, which he said has provided the backbone to the portfolio for a number of months. Besides the larger pharmaceutical stocks such as GlaxoSmithKline and Shire, he also has a number of smaller biotechnology holdings, including Skypharma and GeneMedics.
While adding to existing holdings he feels are undervalued, Dwane is also gently moving into economically sensitive areas of the market, looking to gain the maximum upside when the market starts to turn.
He said: 'We have been trying to gain exposure to early parts of the cycle and have been buying mining stocks, building stocks and other early cycle areas like Johnson Matthey.'
Dwane has also moved overweight telecoms on an unexpected earnings growth play, believing the market has oversold many of the quality names in the sector such as Cable & Wireless and Colt Telecom.
Eric Moore, manager of the Gartmore UK Growth fund, also targets unexpected growth, rather than following an absolute-return philosophy.
The fund has underperformed over the three years to the end of August, posting growth of 4.73%, some 14.94% below the sector average. Moore is candid about the fund's performance, noting that while growth has been out of favour as an investment style over the past 18 months, there was also a timing issue behind the portfolio's sluggish returns.
He said: 'We have probably been too bullish about the impact of the interest rate cuts and underestimated the extent of the downgrades in the market.'
The fund was more aggressively focused early in the year and had to be more defensively positioned in June as the negative market conditions dragged on.
Moore and his team gravitated toward a greater large-cap bias, reducing his overweight small-cap position and upping defensive holdings.
The fund has a diversified portfolio of around 90 stocks, enabling greater numbers of small-cap holdings.
Moore said: 'To get small-cap exposure, we tend to buy little bits in more companies. Within the 90 stocks, there is a sub-portfolio of 20 stocks that probably make up 6% of the fund.'
Moore works closely with his small-cap colleagues in order to prevent this tail on the fund taking up a disproportionate amount of his time.
As the valuations for defensive stocks start to look increasingly full, he is beginning to spot attractive opportunities elsewhere in the market.
He said: 'We are looking at taking money out of defensives cautiously, looking for a few bargains but staying relatively defensive overall.'
HSBC is now trading on a similar yield to British American Tobacco, Moore noted. He believes the bank is a bargain at that price, given it is a major global player, with only 30% of its business exposed to Asia.
Oil companies are also starting to reach more attractive valuations, he said, following the reversal of a price spike after the terrorist attacks in the US.
He added: 'Oil is an interesting one. We have been a bit underweight oil but from here I am inclined to buy because these stocks are discounting a $15 per barrel oil price.'
The Standard Life UK Equity Growth fund has also underperformed over the three years to the end of August, delivering returns of 15.68%, some 3.14% below the sector average.
The fund is run with a more cautious large-cap focus, characterised by its below average beta of 0.87%.
Andrew Milligan, head of global strategy at Standard Life Investments, said the group is currently reviewing portfolio construction across its fund range in light of the difficult market conditions.
Milligan said: 'At present, there are very few themes in the market apart from the obvious, such as the flight to quality companies or the those with the perception of quality.'
He added that until the political climate becomes clearer, the markets may well remain volatile.
Regression analysis: Regression statistics can be used to compare the relationships between funds, markets or a specific benchmark index. They do not make the assumption that the variables (funds) are related as cause and effect, but permit them to be influenced by other variables (markets).
Alpha: The Alpha describes the theoretical reward obtained by one investment when the second investment has a zero return. To calculate the Alpha, the returns of each are taken and compared together to identify their relationship. This reveals relationships between investments in both bull and bear markets. When applied to portfolios, it can be considered to be the return over and above (or below) the market through portfolio strategy. Good managers have a positive Alpha.
Beta: The Beta is the amount the first fund moves when the other moves by one unit. Beta is a measure of relative volatility (absolute volatility is calculated by standard deviation).
If one fund always goes up and down by 1.5 times of the performance of the index, its Beta will be 1.5. This implies that if the return of the index is positive, then 1.5 times this positive return can be expected of the fund. If the index goes up (or down) 10%, the fund goes up (or down) 15%. Beta represents the volatility of the first investment versus the second. It is only an estimate and to be accurate there has to be a perfect correlation between the two investments.
Correlation: Correlation shows the strength of a linear relationship between two funds. A perfect correlation is when the investments behave in exactly the same manner. A perfect positive correlation is represented by 1, perfect negative correlation by -1 and no correlation with a 0. A perfect negative correlation suggests that for every 1% movement by the index we would expect to see -1% movement return on the fund and vice versa. This is an important factor when using modern portfolio theory.
Source: Standard & Poor's
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