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Citywire Discovery: what’s going wrong with global small-cap managers?

Why is every manager in the Global Small & Medium Companies sector struggling?

Why is every manager in the Global Small & Medium Companies sector struggling? It should be one of the easier gigs in the fund world – seeking out under-researched gems around the world and beating a volatile, expensive index – but the sector’s managers have collectively failed to impress.

On three, five and seven-year views the average manager in the sector has posted negative risk-adjusted returns – minus 0.11, 0.13 and 0.06 respectively. Over 10 years the average information ratio is only positive because the peer group is small enough to have been skewed by the one and only manager to record a positive number in that timeframe, McInroy & Wood’s Tim Wood. The other veterans all have negative ratings.

The one-year data are similarly positive on average thanks only to two star teams, BlackRock’s Citywire A-rated pair of John Coyle and Murali Balaraman on 1.1 and Kasper Billy Jacobsen and + rated and Trine Uggerhøj of Sparinvest on 1.6. Exclude them and the large peer group has a miserable average information ratio of minus 0.18.

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Of course, risk-adjusted numbers tell only part of the story. Investors who looked purely at these managers’ total returns would have every right to rejoice. Over the past year, the average manager has produced an impressive 18.8%. The return is in double digits over three years too, and in triple digits over five years.

So surely it would take the bitterest of curmudgeons to snipe over negative information ratios when so much money has been made for investors. Yet they are worth bearing in mind, and not just as ammunition for passive advocates.

Citywire develops the risk-adjusted numbers quantitatively from a manager’s – not the fund’s – information ratio. This is distinct from other measures such as the Sharpe ratio, which is based on a nominal risk-free rate, by separating returns generated by benchmark moves from those generated purely by the fund manager. The information ratio thus reveals the return a manager has achieved in relation to the risks taken in deviating from a specific benchmark – which in the case of global small and mid-caps has been surging.

The preponderance of negative risk-adjusted performance in this sector does therefore indicate that most investors would be better off with a tracker. But in such a treacherous environment, these Citywire Discovery data highlight the minority of managers – profiled next – who have defied the odds and added value over the years.

The analysis comes from Citywire Discovery, a new desktop system that allows fund buyers and fund groups to access track records of over 9,000 managers tracked by Citywire. It provides unique insights into peer group analysis, performance comparisons and competitor analysis. For more details contact support@citywireinsight.com

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Tim Wood, McInroy & Wood

Tim Wood is both a survivor and a pioneer in this sector, boasting the second-longest track record among the peer group.

His fund, though small at £60 million, has been sustained by its extremely strong performance. Over the past 10 years, Wood has generated a risk-adjusted score of 0.33 – which amounts to a phenomenal total return of 262% as all that alpha has compounded through the decade.

Wood has furthermore succeeded in keeping his information ratio positive over seven, five and one-year periods too. The exception is the three-year timeframe, when his risk-adjusted score slips to minus 0.22. That is primarily attributable to a disappointing 2011, when his fund lagged the index. Wood has rebounded ahead of it every year since, however, so those weaker three-year numbers should soon be behind him.

Three-year total return: 28.4% (sector average: 20.4%)

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Edwin Lugo, Franklin Templeton

One manager who has not endured such a difficult three years is Citywire + rated Edwin Lugo at Franklin Templeton. His fund has now posted positive risk-adjusted returns over one, three and seven-year periods – with his five-year numbers being the outlier, albeit only with a modest minus 0.04 compared with a peer group average of minus 0.06. Wood was the only positive performer in that period, eking out 0.08.

Lugo’s £260 million global small and mid-cap fund is now the only way for investors to tap his talents, after Franklin Templeton soft-closed his European Small Mid Cap Growth fund at £315 million last summer.

Within his concentrated global portfolio of just 45 stocks Lugo is significantly underweight the US, unlike most of his rivals, with just a 19% exposure compared with his benchmark’s 58%. Ireland is in contrast a major bet, accounting for 16% of the fund but only 0.3% of the index. Indeed, Lugo’s impressive returns are built upon his self-proclaimed aggressive move into peripheral Europe in 2010 and 2011.

Three-year total return: 38.8% (sector average: 20.4%)

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John Coyle, BlackRock

Citywire A-rated John Coyle has taken a different approach within his £380 million BlackRock Global SmallCap fund, which he co-manages with A-rated Murali Balaraman.

The fund has an index weight in the US, with small overweights to Denmark and France but a substantial 6.3% underweight in Japan. That brave positioning has not actually harmed it during the Abenomics rally: the fund’s strong risk-adjusted score of 1.1 over the past year places it second in the peer group, while its three-year number of 0.3 is also now far ahead of the sector average of minus 0.1.

That has helped the fund, which launched in 1994 but has only been steered by Coyle and Balaraman since 2005, buck a prolonged stretch of underperformance: it lagged the benchmark every year between 2009 and 2012.

At the sector level Coyle and Balaraman are most bullish on energy and healthcare, while running a 3.6% underweight to real estate.

Three-year total return: 36% (sector average: 20.4%)

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Matthew Dobbs, Schroders

Matthew Dobbs is this sector’s grandfather, with 15 years of experience compared with Tim Wood’s 13. However, this longevity has not served to boost performance: his risk-adjusted numbers are negative over one, three, five and 10-year periods.

Since launch in 2006 the Schroder Global Smaller Companies fund he co-manages with Citywire + rated Richard Sennitt has returned 70%, compared with 74% from its benchmark index. That weak relative performance does not seem to have impaired asset gathering too severely, however, as the fund now contains £177 million.

Investors are perhaps reassured by Dobbs’s far more impressive performance on the Asian mandates where he made his name. His flagship £485 million Asian Alpha Plus fund has returned 12.2% over the past three years compared with a sector average of just 4.6%, and his newer but also Asia-focused Small Cap Discovery fund has produced 2% over the past year while the peer group has lost 3.7%.

Both Dobbs and Sennitt have a background in Asian equities: Dobbs began running his first Asian equity portfolio in 1985, while Sennitt joined Schroders in 1993 as an analyst on its Japanese desk. They are accordingly overweight Asia in their global small-cap fund, although the Americas are still their greatest regional exposure.

Three-year total return: 26.5% (sector average: 20.4%)

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