UK equity manager performance through ‘micro factor’ eyes

In part one, we looked at factors in assessing UK equity manager performance from a ‘macro’ perspective. Now let’s focus on the ‘micro’.

Over the long term, we observe that the average UK equity manager exhibits a bias towards size (i.e. investing in smaller companies). The bias towards size has been persistent through time, with other factors changing. The chart below illustrates this trend clearly, with nearly 100% of the manager universe exhibiting a bias towards size, and increasingly more than 75% of the universe also offering a bias towards quality. Note that the sums of each factor don’t add up to 100%, indicating that investing with active managers offers exposure to more than just a single factor.

These stats offer an interesting and different perspective to the types of UK equity managers available in the marketplace. For instance, of the over 200 managers in the IA UK All Companies Sector, less than 5% of the funds describe themselves as specialised value managers, while certainly not all managers would call themselves small-cap managers, even though most of them consistently express a small-cap bias over time.

From this, the average active manager is likely to have more than one factor bias – size combined with another factor. With size as a factor finding it difficult to grind out strong relative performance in recent years, and value generally evident within a smaller part of the manager universe, this is helpful context to understand the relative performance of managers and why the average manager might underperform in periods that small caps underperform.

The best yearly performance for size was seen in 2020 and 2021, and in those two years we naturally observe active managers performing better, with the average manager outperforming by 3.5% over that time period. Without an understanding of how size performed, and the exposure to factors by managers, it would have been tempting to put everything down to the manager, and we certainly know that is not the case (on the up- or downside).

Putting the macro and micro together

The active UK equity manager universe offers exposure to a range of factors – size is a predominant factor, but other factors are also available for investors. From the macro overview, we can see how factor performance changes over market cycles. We can see clearly how this has impacted active manager performance in the UK, and it can also be applied to other regions.

Given factor exposure can reveal much of the realised and expected performance of managers, consistency or stability of factor exposure is important.

For instance, is the factor exposure stable or does the manager try to ‘factor time’ the market? If the latter is true, how credible is that part of the investment process? If the manager claims to be a pure stock picker, it is important to look for evidence of a manager’s consistency to a factor, and this should be across different time periods and market environments. Hence, a robust manager research process is key to carry out this work in a consistent fashion.

For those that build portfolios, understanding a portfolio’s factor exposure over time is also important in understanding the portfolio’s performance.  We prefer creating portfolios with balanced factor exposures that we could tilt across different factors over time. This avoids the reliance on one particular factor in determining the outcome of a portfolio’s performance, and instead brings a team-based approach to factor investing.

In our sport of seeking to achieve long-term investment excellence, we believe taking a factor consistent approach to manager selection and portfolio construction can make a big difference in overall portfolio outcomes.

The value of investments and the income from them can go down as well as up and you may not get back the amount invested. Past performance is not a guide to future performance.