Asset AllocatorNov 16 2018

Faltering alts hurt DFMs; Can funds skip the track-record test?

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Welcome to Asset Allocator, FT Specialist's newsletter for wealth managers, fund selectors and DFMs. We know you're bombarded with information, so each day we'll be sifting through the mass to bring you what you need to know, backed up by exclusive data and research.

 

Hedge fund hurt: a poor sell-off for alts

Two common definitional errors made by those outside the investment industry: describing all who work in financial services as "bankers", and believing all asset managers to be "hedge funds".

In fairness, the latter assumption isn't as inaccurate as it once was, because the line between the two really can get pretty blurred nowadays. Wealth managers' alternatives exposure is populated by a variety of hedge fund holdings, in the shape of what were once known as "Newcits" - strategies run by hedgies in a Ucits format.

So DFMs will have been as disappointed as anyone by hedge funds' collective performance in October. The worst month for such strategies since 2011 meant many failed to protect on the downside at all.

Clearly, not all such funds are designed to do so. The Ucits hedge fund universe is as disparate as they come, ranging from mortgage-backed securities strategies to more obvious safety plays like market neutral portfolios.

But the overriding reason for holding these funds is the expectation they'll prove uncorrelated to the wider market. That didn't pan out last month.

The chart below shows the near-term performance for five of the most popular strategies, according to our fund holdings database. We've excluded funds run by firms operating in the retail asset management space in order to look more closely at dedicated alternatives providers.

It's not a particularly pretty sight - trend-following funds, in particular, were hit hard in October. But the figures also underline how important fund selection is in the sector.

Winton Absolute Return Futures held up pretty well despite the whack taken by many peers. But the BH Macro trust is the real standout, continuing the strong performance it's recorded all year. Of the others, Aspect Diversified Trends has now suffered three serious drawdowns in 2018, and last month may well have been the final straw for many holders.

But while hedge fund strategies such as these account for about a third of all alternatives names in our fund holdings database, and just under a quarter by volume of selections, it's absolute return holdings that still dominate this area. And many of those funds have also had a torrid time of it this year, as we'll discuss in more detail in the coming days.

Track record testing

We spoke last week about Miton European Opportunities being one of the more popular European equity funds despite its relatively short track record. A closer look at all equity asset classes shows it's very much the exception rather than the rule. Just 20 of the 401 active equity funds in our database have a track record of less than three years.

The Miton managers' status as JOHCM/Thames River alumni is important here. Of the 20 funds mentioned, a common thread is often either those running the same strategy at a different firm (eg Polar Capital UK Value Opps), or managers extending their process to a new part of the market (like Evenlode Global Income).

A final category is those firms who have brought a long-running process to the Ucits format for the first time. This is typically new managers' best chance of success, whether it be the likes of RWC Global Emerging Markets or - outside the equity universe - those responsible for closed-ended property or alternative credit strategies.

Missing is almost any evidence that DFMs are willing to back a new strategy or manager if there's no past performance for them to verify. An occasional exception is for funds which target a niche part of the equity market, such as Smith & Williamson's Artificial Intelligence fund. But most are holding off even then.

What this analysis doesn't include is managers who have taken over existing funds within the last three years. Fund firms have got better at succession planning, and at communicating these plans: a big slump in assets following the departure of a "big name" manager is less common than it once was. Providers are far more likely to retain assets than to gather them from scratch nowadays.

If there's one other lesson from all of the above, it's that wealth managers don't feel the need to take chances in a rising market. Whether that will change should volatility prove to be here to stay - or whether it leads to a further hunkering down in terms of fund selections - is an open question.

Another curveball

Another callback to finish: At the end of October we discussed a couple of points by Columbia Threadneedle's Toby Nangle on the US yield curve. His generally upbeat assessment was that a flattening curve, such as we're seeing now, doesn't have to mean recession.

Other views can and do differ. For a more downbeat assessment, look no further than Jupiter Strategic Bond manager Ariel Bezalel. Speaking at the annual Chelsea/FundCalibre Investment Dinner yesterday, he emphasised that the global yield curve - the spread between 1-5 year and 5-10 year maturity buckets of a given global bond benchmark - has recently turned negative for the first time since 2008.

He's much more bearish about what this means: a sharply slowing US economy and a global "hangover" next year as central bank liquidity is withdrawn recession risks return.

Even the usual rejoinder about US jobs growth being the strongest since 1969 was dismissed; the manager points out that was soon followed by a recession in 1970, albeit a mild one. So consider the yield curve discussion well and truly evened out.