Baillie Gifford American, Matthews China Small Companies and Premier Miton European Opportunities are some of the 28 active overseas equity funds that have outperformed their benchmarks with high tracking errors.
Although the global economy is becoming more and more interlinked, not all overseas equity markets have performed equally with countries exhibiting different local economic conditions and sector make-ups.
Over the five years between 2015 and 2020, US and Chinese equity markets stand out as the strongest performers, with total returns almost twice as high as European equities, while Asia ex Japan and Japanese equities were somewhere in between.
Performance of MSCI USA, China, Asia ex Japan, Japan and Europe over 5yrs
Source: FE Analytics
Against this backdrop, Trustnet looked at the five-year performance of five major overseas Investment Association sectors: IA North America, IA China/Greater China, IA Asia Pacific excluding Japan, IA Japan and IA Europe excluding UK.
The funds were narrowed down to those with a tracking error above 7 and outperformance of the benchmark above 30 per cent, to single out strategies that delivered strong returns while diverging from the index.
The tracking error measures the consistency of excess returns – the lower the tracking error, the closer the manager follows the benchmark; the higher the tracking error, the more the manager deviates from the benchmark. Where funds do not state a benchmark, we used the most common index in their sector.
Also included the table were correlation (which measures the strength of the relationship between the fund’s performance and the benchmark), and R-squared (which measures to what extent the variance of the benchmark performance explains the variance of the fund performance). The funds were sorted by their relative outperformance against benchmarks.
Source: FE Analytics
Across all 398 funds within the five sectors with a five-year track record and data readily available, the average tracking error was 5.6, the average correlation was 9.19 and the average R-squared was 0.85.
Nine of the 29 funds in the table were in the North American sector, eight were Japanese, six were European, three were Chinese and three were Asia Pacific funds.
The £7.9bn Baillie Gifford American fund was the highest outperformer across all the sectors with a total return of 402.09 per cent over the period.
The fund saw most of its gains occur last year after being the highest performing fund in the entire Investment Association universe. Over the course of 2020 many of its largest positions in Tesla, Shopify and Amazon rallied dramatically.
Managed by Gary Robinson, Tom Slater, Kirsty Gibson and Dave Bujnowski, the fund follows Baillie Gifford’s long-term benchmark agnostic approach to investing and also exhibited the highest tracking error in the list.
The $471m Matthews China Small Companies fund, run by Andrew Mattock and Winnie Chwang, was the next highest outperformer, with a return of 213.59 per cent over the five-year period.
The small-cap focused fund dramatically outperformed its MSCI China Small Cap benchmark’s return of 37.56 per cent and it exhibited one of the highest tracking errors amongst all the IA China/Greater China funds.
The team focuses on investing in industries leveraged to China’s increasingly transforming economy that is seen to be driven by fast growing domestic consumer demand.
Small-cap equity strategies were common outperformers with high tracking errors across all the overseas equity markets.
Focusing on an under-researched area of the equity market, small-cap active managers often have more opportunities to take contrarian positions in fast growing smaller companies and can significantly deviate from their benchmark index.
Indeed, the highest performing European equity fund with a large tracking error was the £2.3bn Premier Miton European Opportunities fund run by Carlos Moreno and Thomas Brown.
The European equity strategy invests across large-, medium- and small-sized companies but has a bias to mid-caps.
While some of its top positions include European giants such as €200bn Dutch semiconductor supplier ASML, it also holds large stakes in medium-sized firms such as €6bn French semiconductor material business SOITEC.
Several Japanese equity funds also featured in the table. The highest performing Japanese equity fund was the £1.5bn Legg Mason IF Japan Equity fund run by Shiozumu Investments, an active specialist Japanese equity manager.
The fund is focused on Japanese domestic-oriented sectors that the manager believes will be major beneficiaries from workstyle reforms. These include companies in medical and nursing care services, consumers’ lifestyles and internet-empowerment related companies.
Of the Asian Pacific ex Japan equity funds, the highest performer featured in the table was the £161m BNY Mellon Oriental fund.
Managed by Sophia Whitbread, Ian Smith and Paul Birchenough, the fund has a growth bias and is currently overweight consumer services, technology and basic materials.
Its largest position is a 6.3 per cent stake in Chinese multinational technology company Tencent, however its recent performance has been driven by its investments in Chinese solar glass manufacturers as well as companies in the EV-supply chain.
Despite the dramatic outperformance of some funds, high tracking errors don’t always necessarily translate to outperformance. There were several equity funds that diverged from the index and had significant underperformance.
The table below shows the bottom performing funds with tracking errors above 7 and underperformance of over 30 per cent for the five-year period between 2015 and 2020.
Source: FE Analytics
The $751m Legg Mason ClearBridge US Aggressive Growth fund was the lowest relative performer with a total return of 71.88 per cent. This was over 98 percentage points lower than its Russell 3000 Growth index benchmark, which returned 170.70 per cent over the same period.
While there were a number of growth strategies that underperformed, equity funds focused on value and income strategies were prominent underperformers over the five-year period.
The ¥35bn Nomura Japan Strategic Value fund, managed by Kentaro Takayanagi, had the highest tracking error of the underperformers.
The value-orientated strategy was amongst the lowest returning underperformers for the period as the value investment style was out of favour in the Japanese equity market over that time frame.