A finger on the scales

Boutique is better: it’s not exactly a phrase you hear regularly repeated around the investment industry, but most fund buyers agree with the underlying sentiment. 

Amid the wave of M&A that continues to sweep across the fund management sector, industry analysts hold similar views. Better to be very small, or very large, rather than stuck between two poles with no obvious way to add further scale.

That doesn’t quite hold when it comes to DFMs’ own preferences, however. Our analysis of wealth managers’ selections shows that mid-sized firms aren’t so much a squeezed middle as a sweet spot for fund buyers.

The chart below takes four equity sectors and ranks all DFM fund picks in these areas by the size of their parent company. For income, the results are perhaps as you’d expect. But when it comes to growth offerings, it’s clear that mid-sized groups are still punching above their weight.

We’ve defined this middle ground as fund managers with between £10bn and £50bn in assets. For wealth managers, the attraction is that these firms combine the necessary resources with that mystical thing - a distinct investment ‘culture’. This group includes many of the sector’s favourite fund houses - from Artemis, to JOHCM, to Polar Capital - though some of these firms insist they’re no longer 'boutiques' as such.

For market observers, it’s similarly a question of definition. The Investment Association may define a boutique as a firm with under £5.5bn in assets, but other observers would argue the upper limits are higher than even our own cap.

And if there is a gap in interest, it’s for firms between £50bn and £100bn in size. There’s hardly a single asset manager in our database that meets this size requirement. The lesson must be that this is the point at which firms either flatline or are swallowed up by a bigger rival. The squeezed middle still exists, it’s just a little larger than it once was.

Chipping in

The risk asset rally enjoyed by most investors this January is starting to look more and more familiar. Price action has moved beyond a simple rebound and started to more closely resemble the trends seen in the first half of 2018. 

For evidence, look at US-listed chipmakers yesterday. Their specialist index shot up 5.7 per cent on Thursday, virtually its largest daily gain in a decade. Set against a rise of just 0.1 per cent for the S&P 500, it brings to mind the start of last year, when tech disconnected from the rest of the market.

This has long been one of the more volatile parts of the tech sector - last year the Philadelphia Semiconductor Index dropped 8 per cent compared with a 1.6 per cent decline for the S&P IT index. But what’s notable about yesterday’s activity is that it wasn’t just driven by sentiment, but also better than expected earnings.

A niche area this may be, but that’s much better news for technology investors than the likes of Apple’s January 3 profit warning that grabbed the headlines at the start of the year.

Wealth managers have far from given up on the sector, either: our fund database shows little sign of DFMs dumping their holdings. And retail investors appear to think likewise. Scottish Mortgage began trading on a discount at the start of December for the first time in almost a decade - but that was quickly erased within a matter of days. Investors continued to trade the trust at a premium even during the end-December sell-off.

But the two trusts explicitly dedicated to technology, run by Polar Capital and Allianz, both still sit on small discounts. Polar, which has underperformed its rival for the past couple of years, hasn’t been on a premium since last April. The Allianz portfolio began trading below NAV at the start of December and hasn’t quite recovered yet. If the tech rally is to reassert itself, there’s an opportunity there for DFMs willing to back closed-ended products.

Aiming too high

One thing that has caused discretionaries renewed woe in 2019 is the Aim market. Blow-ups are common in the alternative market, of course, but few are as high profile as Patisserie Valerie, which has headed into administration amid an ongoing enquiry over a £40m accounting fraud.

Wealth managers can’t be blamed much for taking exposure, given the company’s auditors, regulators and management themselves are still trying to work out exactly how the fraud took place. But it is another reminder that the risks involved in Aim investing aren’t simply offset by the tax advantages.

The market has rebounded this month in line with other equities, but the 20 per cent fall sustained in the fourth quarter won't be so easy to make good. Add to that issues with other high-profile names in the index - chief among them former favourites like Asos and Abcam - and the outlook's looking murkier for specialist investors.