Changing up

The “turning point” that emerged for many at the end of 2018 has been frozen in its tracks so far this year. At the moment, investors aren't making any fast moves. Instead, they're still picking up the pieces after December's fractures.

Wealth managers will have welcomed the chance to take stock and consider whether more action is necessary. But first we need to consider exactly how they were positioned coming into 2019 - and the latest statistics from our asset allocation database can help us do just that.

Despite - or perhaps because of - the volatility seen during the quarter, aggregate changes in the final three months of last year were limited in scope. But the movements shown by the chart below can be summed up as follows: Equities, largely of the European variety, were trimmed to make way for greater bond exposure. And alternatives were cut back in order to increase cash weightings.

There are two forces at play here: the first is an acknowledgement that bonds’ diversifying qualities proved effective again at the end of last year. The second is that several wealth managers decided alternative assets had proved less than reliable - even if December brought better news on that front.

Both these points chime with topics we touched on last week: they show the 60/40 portfolio’s qualities aren’t entirely out of fashion with DFMs.

So this wasn’t quite the buying of the dip stance typically seen during a sell-off. And when it comes to the big fall guy of the period - European equities - there’s a sense that discretionaries were never fully convinced of the merits of continental stocks. They’ve cut exposures for the second quarter in a row amid signs that last year’s tentative economic recovery is starting to stutter.

But sentiment is more resolute when it comes to other equity regions. In keeping with changes made in the previous quarter, few were prepared to use the falls as an opportunity to cut back on UK stocks. And while US and global equity allocations were pared fractionally, Japan and emerging market exposures edged higher. Time will tell if the latter changes prove the start of something structural rather than tactical.

Behavioural barriers

From buying high and selling low to other timing errors, returns can be at the mercy of professional investors’ own behaviour more often than they’d like. And while awareness of behavioural biases can help limit the damage, there’s always something new on the horizon that can adversely influence decisions.

The latest threat comes in the form of that old bugbear, Mifid II. If the volatility of Q4 wasn’t enough to panic clients, the accompanying 10 per cent drop warnings that reached many around the end of the year are unlikely to encourage measured thinking.

DFMs themselves are at risk of rash behaviour. Hawksmoor research head Jim Wood-Smith has predicted that wealth firms could end up playing it safe in the run-up to a big market event to limit the risk of incurring a 10 per cent fall. As he notes, wealth managers can either ride it out and take the chance of having to write to every client, or implement a “short-term derisking” of portfolios.

Here’s his view of the consequences:

Portfolios across the industry are going to be managed, to a degree, with an eye on minimising short-term drawdown risk. In so doing, the upside potential gets capped. And over the longer-term, portfolio performance will suffer as a result.

So another form of ‘window-dressing’, and one that hurts clients in the long-term. There are obvious solutions - keep communicating with clients, and stop worrying about the 10 per cent letters - but not all will be capable of ignoring the impulse to reallocate.

Spotting this kind of shift will be difficult: what looks like unnecessary derisking to one observer will be simple prudence to another. But if DFMs’ risk appetite really is stronger than their peers', this is one way it might end up falling back into line.

Cutting back

Speaking of taking less risk - who now remembers the theory that bond funds would have to cut charges to remain attractive in an era of lower returns? 

Fees may have fallen gradually over time, but providers know they still have something of a captive audience for their fixed income products. When it comes to charges, the threat posed by passives is still a bigger issue for active fund distributors than the idea of limited returns.

Still, after a tough year, wealth managers could do worse than renew their calls for better deals. And there are some examples they can point to, the latest being TwentyFour’s decision to cut its Monument Bond fund fees by 15 basis points. 

That reduction is probably due to economies of scale as much as anything else - the fund’s growing popularity with DFMs saw assets shoot up last year - but there’s nothing like a bit of healthy competition to get providers looking over their shoulders.