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Asset Allocator

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Fund favourites stand firm amid market chaos; DFMs' downsizing problem foils buyers

Welcome to Asset Allocator, FT Specialist's newsletter for wealth managers, fund selectors and DFMs. We know you're bombarded with information, so each day we'll be sifting through the mass to bring you what you need to know, backed up by exclusive data and research. 

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Keep it consistent

Consider the events of recent quarters and it’s no surprise that the likes of BMO’s FundWatch survey report a significant drop in the number of consistent funds. 

A more notable point was raised by a recent Morningstar study that questioned the value of consistency as a concept. It found funds that had been consistently top quartile over three consecutive years were less likely than other portfolios to have maintained that advantage over a ten-year period.

That finding makes sense: a relentless focus on a particular investment style can reap rewards for a while but doesn’t always spell long-term success. Similarly, volatile portfolios can happily top the charts for a time, only to enter a world of pain once they fall from grace.

But wealth managers are unlikely to entirely disregard the impact of whipsawing markets on their holdings. So we’ve looked into our fund selection database to examine just how DFMs’ top picks have fared over three discrete, if short-term, periods: the first nine months of last year, the final quarter, and the opening weeks of 2019.

Judge performance on this relative basis and the findings don’t make for bad reading: half of DFMs’ favourites’ saw their Q4 2018 quartile ranking either remain where it had been for the first nine months, or move by just one.

And the biggest shifts worked to the benefit of discretionaries: their natural caution on EM and Asia meant three quarters of their favourite selections in these areas moved from fourth quartile to first.

This year’s figures are also reassuring: despite the rapid rebound in market performance, 70 per cent of favourite funds are performing more or less the same in 2019, on a relative basis, as they were in the fourth quarter. Consistency may not matter all that much, but wealth managers will still be able to draw some comfort from how their selections have performed in recent months.

Downsizing

As DFMs’ model portfolios continue to grow, their ability to invest in smaller funds moves in the other direction. The swelling of industry assets has pushed the minimum viable fund size up beyond £50m or even £100m in some quarters. So the theory goes, at least.

Dissenting voices have emerged: in the ETF world, where plenty of funds never reach this kind of critical mass, new research suggests more than a third of European fund selectors would invest in strategies with less than £20m in assets.

But the MPS issue looms large in the UK. Our own database of model portfolio selections, which tracks roughly 1,000 different funds, underlines this fact. Of that total, just 5 per cent are less than £100m in size, and just 2 per cent come in under the £50m mark.

What are these smaller funds? Some DFMs are backing relatively new names such as Oyster Continental European Income, or those that invest at the very bottom of the scale like Liontrust UK Micro Cap.

In other cases, funds may lack clout but meet a specific need. Like Rathbone Heritage, which remains small but proclaims a focus on capital preservation.

That argument is more apparent when it comes to the question of yield: products such as Matthews Asia ex Japan Dividend (£27m) and ClearBridge US Equity Income (£31m) are both among the smaller names. 

And as these examples all suggest, it’s in the equity arena where DFMs are more likely to back a small fund: average MPS equity allocations of 55 per cent plus mean there’s more scope for smaller positions to add something a little different to portfolios.

Yearning for earnings

Earnings season is now in full swing, but true to form markets are already looking further ahead. US businesses’ muted outlooks have led Morgan Stanley to proclaim that an earnings recession - two consecutive quarters of year-on-year declines - is now set to arrive in 2019.

To be clear, that view is based on company forecasts rather than their reported Q4 figures - the latter data hasn’t looked too shabby so far. Charles Stanley notes US earnings growth is “surprising positively”, particularly in comparison to Europe.

Though only a fifth of European companies have reported, average year-on-year growth stands at just 1 per cent, according to the wealth manager, and outlooks here aren’t great either.

The difference between the two markets may be that US strategists can see some light at the end of the tunnel - even if that tunnel is still pretty lengthy. 

Hopes for the fourth quarter of this year are still sky high, with estimated earnings growth of 9.5 per cent. Which suggests there's a good chance investors are getting ahead of themselves. As the FT warns, “Q4 is well beyond the horizon at the moment and yet this is the feel-good scenario that risk assets are hanging their hat on”.

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