The little things in life

DFMs are no strangers to the race to scale up seen across the investment industry. A combination of M&A and organic growth has meant that, like their peers in asset management, the biggest wealth firms are only getting bigger.

One well-known drawback is that those firms with substantial assets can't take the liquidity risk of backing promising small funds, and this limitation is evident in our database of DFM fund holdings. The chart below shows the average size of a fund holding in our MPS tracker for the given equity regions:

Most funds held in the model portfolios we track have more than £200m in assets, with several reaching billions in size. But there is evidence that some DFMs are still able to turn to smaller funds to give their buy lists the edge.

In Europe, there are eight funds that have less than £200m in their principle share class for UK investors. They include names which have come to prominence only in the last few years, such as Oyster Continental European Selection, as well as lesser heralded offerings from established fund houses like Liontrust, RWC and BMO. There's also a handful of small global equity names: Newton Osprey, Rathbone Heritage and Orbis Global Equity.

But in Japan, just one name – JPM Japan Select Equity – meets such criteria. The size of picks here may well reflect a DFM tendency to crowd around established names in this region.

By contrast, selectors' desperation to buck the trend in the US has sent them further afield in search of answers, and that can mean smaller funds (when it comes to assets run in an onshore Ucits structure, at least). Four funds run less than £200m: JPM America Equity, Winton US Equity, THB US Opportunities and Franklin US Opportunities.

That's indicative of a bit of a paradox for fund selectors. The common consensus is that the world's largest equity market is so well-researched that it's tough for active managers to stand out. And yet the active US equity fund universe is still extensive enough that hidden gems can be found more easily here than in any other area.

Small-cap surprises

Now to small funds of a different kind. In all our recent work on buy list concentration, one area we’ve shied away from assessing is small-cap selections. This is partly because smaller companies just don’t account for that much of a typical DFM’s asset allocation - a smaller pool of selections makes it harder to draw definitive conclusions.

But our database of DFM fund holdings still has some worth when it comes to assessing selections at the lower end of the market cap scale. In the UK in particular, our figures show an unusually high degree of dispersion when it comes to fund picks.

In total, wealth managers in our database look to more than 20 different providers for their current UK small-cap choices. That figure’s not so far removed from the number of different asset managers chosen for their mainstream UK equity and/or UK equity income products - despite these asset classes making up much larger proportions of the average DFM model portfolio.

Clearly, then, the UK Smaller Companies space is much changed from the days when fund selectors looked no further than Harry Nimmo or Dan Nickols. Both managers still feature in our database, but they’re joined by rivals old and new: names as varied as Unicorn, BlackRock, Livingbridge, Teviot and the managers of the new Odyssean investment trust.

Is there an obvious reason for wealth managers casting their net so far and wide? One obvious conclusion would be that the risk/reward equation is less pressing. Small caps may be riskier, but as they form a much smaller part of portfolios than other asset classes, the consequences of a blow-up are less severe. Add the potential rewards on offer, and the attractions of seeking out a lesser-known name increase.

Performance data doesn’t necessarily bear this out. Domestic small-caps, in aggregate, have had as tough a year as the rest of the UK equity space. But the dispersion of returns between portfolios - or at least, between those popular with wealth managers - is broadly comparable to that seen for UK equity income and traditional UK equity funds. DFMs diversifying their exposures is clearly a good thing, but at the moment the results aren’t really helping their portfolios stand out.

The dashboard and DFMs

The government’s long-awaited pensions dashboard feasibility study, published yesterday, has removed lingering doubts about its commitment to the project. 

Like auto-enrolment, the current project will be broadly welcomed as a way of nudging people towards saving more for their retirement. But the principle beneficiaries of the project - ie those who need to find more ways to save, if possible - are, by definition, not wealth management clients. 

So from DFMs’ perspective, many of the lingering issues of recent months - whether state pension pots will be included on said dashboard, how many dashboards there will ultimately be, who’s going to pay for the service - have been of limited interest.

That said, one unanswered question cleared up by the feasibility study could have consequences for discretionaries. To the surprise of some, the Treasury said yesterday that a trusted third party, such as a financial adviser, should be allowed access to a consumer’s pensions information in certain circumstances. 

Clearly, advisers’ existing fact-finding processes already attempt to establish these details. But the ability to verify this information via the dashboard will represent another helpful input for advisers, particularly as clients approach retirement.

That, in turn, extends to DFMs who work with those advisers, either internally or on an outsourced basis. It’s another hint that dedicated decumulation portfolios (and the asset allocation decisions that inform them) should be right at the top of wealth managers’ agenda.