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Home pride: Who's sticking by UK equities? Dissecting DFMs' passive picks

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. 

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Home alone: the UK equity split

Are UK equities a bargain or a disaster? Many investors have decided to ditch or significantly reduce their allocation, in no small part due to an uncertain post-Brexit outlook. On the other hand, many now say UK shares look cheap on the back of this trepidation.

What do DFMs think? We've spoken before about how wealth managers, in aggregate terms at least, were reluctant to let weightings drift lower amid a tough third quarter for UK stocks. But that's not to say there aren't variations. Our chart below shows how wealth firms captured by our MPS tracker are allocating at the moment.

The chart implies many are content to keep exposures at relatively low levels. And some have, in fact, made significant reductions more recently.

Sanlam, for one, cut its allocation by some 12 per cent. This was in part down to a change in the benchmarks the team uses, but Barry Cowen, a member of the investment team, isn't alone in thinking that Brexit uncertainty means it may prove “ill-advised” to be overweight domestic equities as it stands.

Others are more sanguine. Here’s Peter Dalgliesh of Parmenion, on the company’s 35 per cent position in the UK:

Given the UK has historically offered medium to long-term investors attractive risk-adjusted returns from companies representing a broad range of sectors, geographies and market opportunities, we believe the value on offer more than compensates for near-term political risk.

So while Parmenion's more upbeat, note the emphasis on the medium to long-term outlook investors may need to maintain until this opportunity pays off. 

The question that remains to be answered is whether the opportunity cost is worth it, given the relative attraction of home shores versus the “elevated valuations” that Dalgliesh, and many others, see elsewhere.  

ETFs versus trackers

The Investment Association has announced that, due to their popularity, it will consult on the idea of including ETFs in its fund peer groups. A clear sign, if any, that there is an appetite for them among investors. But how interested are DFMs?

Adverse as they are to portfolio churn, wealth managers have been known to take tactical positions using ETFs, particularly when it comes to assets with unpredictable price movements. Look no further than the recent shifts in the oil price for an example of such an asset.

So a tactical approach does have its benefits. That's not the only reason discretionaries use ETFs, but either way the rise of smart beta products has clearly increased the attraction of such funds versus conventional passives. In an effort to gauge where the balance lies, we looked at how often DFMs in our database used ETFs compared with regular trackers.

The results suggest that many wealth firms still prefer the latter. Of the 2,000 cases where funds were held in MPS ranges within our database, 8.9 per cent were trackers, while 6.7 per cent were ETFs.

A closer look suggests that tracker funds are still seen as building blocks for major asset classes. They remain dominant in the equity space, but do have roughly equal representation to ETFs in fixed income.

When it comes to bonds, tactical preferences for some assets, such as linkers or short duration products, may explain the take-up of ETFs here.

The one area of clear ETF dominance is in specialist areas, which range from single-sector plays to commodity positions.

Given their focus on the longer term, it’s unlikely DFMs will turn to all-out tactical moves any time soon. But with price pressure unlikely to go away, there’s a chance ETF demand gets another boost as wealth firms eye up smart beta offerings whose costs look attractive compared with their active counterparts.

You say tomato...

We've spoken before about an important question facing the growing number of DFMs who run ethical portfolios: can they, or the funds they use, invest in Faang stocks, given ethical criteria? It's not an easy one to answer, and a stance either way will likely have an outsized effect on performance.

However, this particular concern is only part of a deeper confusion which looks set to grow. How are DFMs, or their clients, defining ethical?

A look at one new fund in this space illustrates the difficulties here. M&G has launched a sustainable equity fund that will focus on "positive impact" investments.

The asset manager does detail the different areas, and type of holdings, it will focus on. But the dispersion of labels and approaches available means that, at least when it comes to model portfolios, DFMs may either have to keep their options open or come up with a wider variety of offerings.

As the FCA's Andrew Bailey recently noted, ethical propositions look to be one big growth area for asset and wealth management in future. But this growth could only make the space more fragmented, making life trickier for providers.

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