Are the tides turning for UK equities?Contributor Alex Dryden
- A falling pound and a stabilisation in commodity prices are changing the dynamics for UK equity investors. So far this year, only 21% of active fund managers have outperformed the FTSE All-Share Index, compared to 79% in 2015.1
- Top decile UK fund managers in 2015 had, on average, a 75% allocation to mid and small cap stocks. To put this in perspective, the FTSE All Share has just a 20% weighting to mid and small cap.2
- Given the potential for a turnaround in large cap stocks, investors should assess whether they are comfortable with taking on such a heavy overweight to mid and small cap stocks.3
Consensus trades have driven outperformance
Over the last decade, the UK equity investment landscape has been shaped by two major trends: the outperformance of small and mid cap stocks, and the underperformance of commodity sectors. The UK has been one of the fastest-growing economies in the G8, expanding by 2.1% a year over the last five years compared to a G8 average of just 1.5%. The relative strength of the UK economic recovery has driven significant outperformance in more domestically exposed mid and small cap equities vs. the internationally exposed large caps. From 2006 to 2015, the FTSE 250 has returned 12.7% on annualised basis. Small cap equities have also performed well, returning 7.8%. In comparison the FTSE 100 has delivered annualised performance of just 6.0% since 2006.
The second major trend that has driven market performance has been the underperformance of commodity-related companies since 2008. The boom caused by rapid urbanisation in China had seen the Bloomberg Commodity Index surge 160% from 2000 to 2008. Since then, a combination of oversupply and a drop in Chinese demand has triggering a protracted bear market. The index has fallen 70% since its peak in February 2008. Falling commodity prices have had a disproportionately large impact on the performance of UK large caps, as commodity-related names made up over 30% of the index in 2008. Today, their weighting has halved to just 16%.
Due to two major trends unique to UK equities, UK active fund managers have been able to significantly outperform the FTSE All-Share Index in recent years
Exhibit 1: Top quartile excess performance of active fund managers by region
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The value of investments and the income from them can fall as well as rise and investors may not get back the full amount invested. Past performance is not a guide to the future.