The average European ex UK offering in the Morningstar category has underperformed the MSCI Europe ex UK index by around 2.7 percentage points.
Nevertheless, the sector average remains ahead of the index over three, five and 10 years, suggesting active managers have added value in aggregate over these periods.
Given the robust longer-term performance track record of active funds in the sector, then, why did 2016 represent more of a struggle?
Style reversal
One reason was that there was a reversal in the style leadership in the market during the second half of the year.
Having been out-of-favour since a strong performance in 2013, value outperformed growth in the latter half of 2016, with some of the more cyclical areas of the market rallying after a prolonged period of market leadership by stocks classed as sturdy, low-volatility and quality.
Given the average fund in the sector has had a higher allocation to growth stocks than the index, and consequently a lower allocation to value stocks, this change in the market environment constituted a headwind to performance.
Basic materials was the top-performing sector over the year to the end of February 2017, closely followed by oil & gas, and both contributed to this reversal in the market dynamics that occurred through the course of the year.
Basic materials constituted a headwind to the relative performance of the average fund in the peer group because it was underweight in the sector, and resources as a whole, relative to the index.
Change reaction
Changes in active funds’ sector allocations indicates some reaction to the changes in the market. The category average fund started 2017 with a small overweight in energy, while the underweight position in materials narrowed during the course of 2016.
Telecommunications and utilities were the worst-performing sectors over the period. The category average fund has been underweight in utilities for a number of years and was also underweight in telecoms for the majority of 2016.
But, given the small proportion of the index these two sectors comprise, the influence on relative performance was reasonably small.
Long-term sector outlook
Gavin Corr, director, Morningstar Investment Management, said: “We have witnessed a noticeable improvement in the economic outlook across Europe, with a corresponding upgrade to earnings expectations for companies that may attract further flows into European equities.
“While prices may continue to rise in the short term, sustainable progress will depend on the continued improvement in the outlook for earnings and a benign political environment, as the returns implied by current prices are close to fair value.”
Click here to see the Europe ex UK funds the watch based on the their three-year performance.
