DFM vs multi-asset

In a competitive world, it sometimes feels like there are just too many crowds from which wealth managers have to stand out. We already know that they can successfully differentiate their portfolios from both the broader fund universe and rival offerings in the DFM space. But there's also another type of competitor jostling for prominence: it's multi-asset funds that are arguably the biggest challenge to DFMs' quest to capture adviser and private client interest.

Our chart below compares the typical asset allocation in a DFM Balanced portfolio, as categorised by our database, with that of an equivalent multi-asset fund. For the latter, we've taken an average of all funds in two equivalent Mixed Investment sectors run by the Investment Association, because they best reflect how portfolios in the database are positioned.

There's a suggestion here that the difference between the two isn't as great as some on either side would have you believe. But perhaps the overall contrast is greater than the sum of its parts: model portfolios are, on the face of things, taking a more risk-on approach. The average model has 5 percentage points more in stocks, combined with a slightly lower cash weighting (6 per cent versus 8.8 per cent in multi-asset funds), and significantly less in bonds. 

Not all these differences are necessarily due to a gung-ho attitude: the lower bond weighting is offset by discretionaries' greater exposure to other investments such as alternatives and property.

But there may yet be questions for wealth managers to answer regarding their risk appetite. Having done some research of their own, one DFM recently told us they were amazed at just how much the average Balanced model had in equities. In the next few days we'll be analysing the drivers for some of those decisions, and take a closer look at whether the December sell-off prompted wealth firms to scale back, or scale up, their risk asset exposure.

Another bond battle

Fixed income allocation decisions remain as tough as ever, but there are always bright spots. At the moment, emerging market debt has two things going for it that tend to prove a powerful combination for allocators: healthy yields, and a recent rally that suggests an uptick in fortunes has already begun.

And unlike with most asset classes, this uptick began well before the end of 2018. The iShares EM local currency bond ETF was up 3.5 per cent in the final quarter of the year. For sterling-based investors, that gain extended to 7.2 per cent.

With the Fed's hiking cycle arguably now on pause, the scene is set for further gains in 2019. Some bond managers think so: Fidelity's team has been adding to both local and hard currency debt, while M&G notes that the near-7 per cent yield on USD emerging market sovereigns is the highest since the financial crisis.

Wealth managers, who tend to take a slightly longer term view rather than dipping in and out of the asset class, will be conscious that the current rally can be seen as simply more evidence of EMD's volatility. 

But there is another factor to consider. Discretionaries' bond allocations tend to have strategic, investment grade or short-duration instruments at their core, supplemented by a small weighting to something like high-yield debt. 

Many might now think that high yield, which enjoyed several years of strong returns until Q4 2018, is starting to look less attractive. 

Our database also indicates that distribution yields on wealth firms' favourite EMD funds are roughly comparable to those on conventional high-yield bond funds for the first time in many years. For many, that might prove too tempting an opportunity to ignore.

In the regulatory spotlight

After years of scrutinising active funds, regulators are starting to hone in on passives, too. ETFs have always been a focal point for those given to alarmist concerns, but other structural changes to the way money is invested are also attracting increasing amounts of attention. All those "passive funds = Marxism" headlines have had an effect.

The latest indication comes from comments made to FTfm by Sven Giegold, the MEP who has proved a thorn in active managers' side in the past. 

His concerns centre on the concept of 'common ownership': the idea that big passive players' holdings in multiple firms in the same sector may ultimately inhibit competition. 

Naturally, the asset managers themselves question whether this thesis is accurate. Yet the ballooning size of these heavyweights means more questions - and more regulation of some kind - is inevitable. The impact on fund buyers is less easy to ascertain, but as we've noted before, most are happy to stick with a small handful of big firms for their passive exposure. That's unlikely to change regardless of policymakers' growing interest in the sector.