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Wealth managers' big career-risk call; A missing asset allocation X-factor

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.


US and them: avoiding American equities

The US mid-term elections take place today, and after the shocks of recent years it's probably no bad thing that they're likely to pass without incident from a market perspective.

But some wealth managers and asset allocators have made controversial calls of their own when it comes to the country. Because while the US understandably plays a sizeable role in the typical DFM portfolio, there is a small cohort who have turned away from the world's biggest equity market entirely.

We discuss some of the reasons for that decision below. But whatever the rationales, there's no denying that the career risk inherent in avoiding the US is a powerful disincentive. And this year the opportunity cost of doing so has been higher than ever.

That said, there remain a few holdouts. The below chart, drawn from our MPS tracker service that monitors wealth manager asset allocations and fund selections, shows dedicated US equity exposures within Balanced models at 50 different DFMs.

Nor has the recent sell-off convinced these holdouts to change their mind. Chris Metcalfe, founder of Iboss Asset Management, is among those standing firm.

Whilst the 7 per cent (in dollar terms) fall during October made the US market cheaper than it was, many markets around the world fell by even more and had been falling before the October correction. There are still more attractive markets than the US.

Iboss, and others, do have some US exposure via global equity funds, which typically have around 40 per cent of their portfolio in the region. But it's not just DFMs who are changing tack - multi-asset managers have also grown more sceptical.

Seneca's Peter Elston sold exposure this summer, believing that tighter monetary policy will hurt the US more than other regions. He sums up by suggesting the rewards, from a performance perspective, will eventually outweigh the risks:

It has caused our funds to slip a bit in the peer group rankings in recent months, given the substantial outperformance of US equities.

[But] being high conviction… is really the only thing that can produce alpha for our customers well in excess of costs.

Missing the X-factor

Invesco's annual survey of factor investing remains unsurprisingly positive about smart beta's ability to grow in popularity among both institutional and wholesale investors. But it also acknowledges there's a long way to go, and other evidence suggests the road is proving more arduous than many first anticipated.

Our fund holdings database shows a limited take-up of such products so far, even in areas where smart beta is supposed to come into its own such as dividend or value investing.

There are just five examples of DFMs using value ETFs in the entire database, while three holders of S&P's Dividend Aristocrats fund make up the entirety of the income-based factor exposure. Specific sector exposures, such as financials, are slightly more common. But there's no sign that factor investing is a movement on the verge of a breakthrough.

One caveat is that our database doesn't account for passive-only portfolios, where smart beta will be much more prominent. But there's also another problem for the sector: the question of what the proliferation of products means for viability. 

Research last year suggested that two-thirds of smart beta products were below a critical mass of £50m. And this wasn't just due to new products having not yet captured an audience; many were found to have remained at sub-scale levels several years after launch.

As with active products in a similar position, it's a bit of a chicken-and-egg issue for wealth managers: they won't invest until funds get bigger, and funds won't get bigger until they invest. And for now, simplicity remains the watchword for selectors.

No news is good news?

One positive from across the pond in recent days has been the resilience of earnings season. Today it's the turn of DFMs' UK equity fund favourites to sweat over a number of major holdings, via a series of third quarter results. 

The good news is there's little in the way of profit warnings to send things awry. Imperial Brands sets the tone with interims that are mixed but not disastrous and sent shares up a trifling 1 per cent.

From wealth managers' perspective, what's more interesting is the major fall in the company's value over the past year which means the stock now yields a hefty 6.7 per cent.

The end result is many UK income managers have stuck by the company - and, because the slump means Imperial now accounts for just 1 per cent of the FTSE All-Share, they're also taking bigger active positions.

Those holders range from well-known backers like Neil Woodford and Threadneedle UK Equity Income to smaller exposures of around 2 per cent held by the Artemis, Man GLG and Gam income funds, according to Morningstar data. So whatever Imperial does next could have an outsize impact on DFM portfolios.
Slightly better results today from DS Smith, which has already achieved the improbable - drawing attention to the cardboard box sector - by buying a competitor this summer. It's held by Ed Legget at Artemis and Marlborough Multi-Cap Income.  Other high-profile names such as Investec's Simon Brazier and Merian's Richard Buxton also backed it as of this summer, per Morningstar. 
Life's hardships are more obvious for William Hill, which has seen shares fall by as much as 8 per cent this morning after cautioning on its outlook.

Its regulatory headwinds have been well-flagged, meaning few UK managers are betting big on the bookmaker for now: no major fund in our database has more than 2 per cent in the stock as it stands. Last but not least, Morrison shares have also been knocked back today - but only slightly, meaning the likes of Schroder Recovery and JOHCM UK Dynamic should take it in their stride.

Further rounds of results will follow later this week - but as it stands the relative calm will be a welcome relief for fund managers and fund buyers.

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