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Battling the benchmarks
Absolute performance remains the critical metric by which clients judge their wealth manager. But by the end of a bruising 2018, many firms would have settled for just beating benchmarks last year.
When we examined how DFM fund selections had done versus indices and the wider fund universe back in October, the results were uniformly positive. But include the final quarter of the year, as we do today, and things look very different.
As the chart below shows, the proportion of funds that managed to beat their benchmarks fell notably in all categories to stand at around 25 per cent by the end of the year. And DFM picks were hit harder than most. Once ahead of the pack in all categories, they ended up leading the way, on aggregate, in just three of the five asset classes analysed.
The good news is that emerging market, Japan and in particular US selections are ahead of the pack. That represents a notable turnaround for wealth firms’ emerging market fund selections, which were trailing the wider fund universe prior to the fourth quarter but have since shown their resilience.
But wealth managers’ UK and European choices have moved in the other direction. That’s particularly clear on the home front - DFM UK equity picks did markedly worse than the All-Share in 2018.
So is this a case of discretionaries again being too risk-on? Not necessarily - three of the five most popular UK funds with DFMs were among the select few that outperformed last year. It’s their other selections that have struggled.
If these funds are being used as satellite picks in portfolios, then a degree of volatility is to be expected and even welcomed. But some wealth managers will be using them as core holdings - and might now be considering whether they should opt for something a little more reliable.
Volatile funds are one thing, the truly woeful another. The importance of what you don’t own might be something of an investment truism, but the theory is supported by many a stock blow-up in the past. And so it goes for funds that continue to languish in a model portfolio after hitting the buffers.
So it’s useful to take a glance at Bestinvest’s latest Spot the Dog report, which serves as a hall of shame for the worst underperformers of the open-ended universe. There are plenty in dire straits this time round: after the calamities of 2018, the number of “dog” funds has jumped from 58 six months ago to 111 now.
But have DFMs been caught out? A scan of our MPS tracker shows that wealth firms have made it through relatively unscathed, by this metric at least: DFMs hold just 16 of the 111 stragglers.
There’s no particular bottleneck of underperformers making it into model portfolios, either: wealth firms held five of the 32 UK All Companies dogs, four out of 18 in Europe and three of the 20 global products. Combine this with the analysis above and it suggests that discretionaries’ UK and European equity strugglers are more mediocre than monstrous.
Elsewhere wealth managers are even less exposed: two (out of 25) from the UK equity income space and one mutt each in the US and EM have made it into portfolios.
DFMs are most likely to back a struggler when it comes to yield. SLI European Equity Income, Somerset EM Dividend Growth and Artemis Global Income are all widely held within our database – and all listed as dog funds. But, as the doghouse focuses on capital growth rather than income, there are some mitigating circumstances here.
Today’s common theme, ie the pressure to perform, finds a neat summary in the news that the Witan Pacific investment trust will allow shareholders to liquidate their positions in two years’ time should returns fail to make the grade.
If it’s surprising that the board has put the future of a 112-year old trust in doubt - the Pacific trust is even older than the regular Witan strategy - that’s only because the funds industry has hitherto set the bar so low. Fewer investors may tolerate underperformance nowadays, but providers usually remain content for laggards to run along in the background indefinitely, so long as they still hold sufficient assets.
This looks, then, like another good example of how trusts can subject managers to greater scrutiny than their open-ended peers.
Unfortunately for the trust sector, there are issues other than returns to consider. A critical board is no longer enough of a USP for closed-ended equity funds. It will take more than an uptick in performance for investors to renew their interest in this kind of strategy.