Asset AllocatorFeb 14 2019

Adviser MPS flaws open door for wealth firms; The halfway houses hurting portfolios

twitter-iconfacebook-iconlinkedin-iconmail-iconprint-icon
Search supported by

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. 

Forwarded this email? Sign up here.

Correlation crunch

The multi-asset threat to wealth managers is one thing, but other rivals shouldn't be ignored, either. And as more financial advisers rely on their own model portfolios, many DFMs will be conscious they’re catering to a market that is morphing back from customer to competitor.

We’ve returned to recent research from Natixis for a little more clarity on this front. Notably, their data on the typical adviser balanced model reveal weightings that are almost exactly the same as DFMs' own balanced models. Both are heavier on the equity than multi-asset funds, with lower allocations to bonds and more in alternatives. 

Indeed, the only point of difference between advisers and DFMs is that the former have even less in cash and fixed income than discretionaries, instead plumping for a materially higher weighting of 8 per cent in real assets.

But there’s an argument that this has pushed adviser portfolios too far away from defensive assets, as the correlation chart below indicates:

While the typical adviser MPS tends to have a near perfect correlation to equities, according to Natixis, there’s barely any link to bonds: the correlation comes in at just 0.13.

What’s more, many advisers seeking diversification through multi-asset funds have instead doubled up on existing allocations. Here’s Natixis:

Many of these [multi-asset] funds simply replicate what the advisers are doing themselves, and as a result have very high correlations to portfolios. Investors need to check whether those that they invest in are truly diversifying.

The fund firm has mentioned this issue before, and says it has seen signs of progress on this front: advisers did start to lower their allocations to multi-asset funds last year. But continued caution on fixed income means they remain even more risk-on than the average wealth manager. 

A convert to the cause

Santander’s surprise decision not to call a €1.5bn coco bond has kicked up a fuss this week, but its immediate consequences have been minimal: the price of Santander cocos has hardly shifted, and the wider market has carried on undaunted.

So wealth managers, too, will barely notice the ripple, particularly as cocos typically represent a fraction of their underlying funds’ fixed income exposure.

But the saga does provide a reminder to check in on how conventional convertibles - which do form a more serious part of many wealth firms’ allocations - have fared during recent volatility.

Categorising these funds has proven difficult for wealth managers: our database shows most tend to classify them as bonds, although IA sector rules mean those with unitised portfolios have been obliged to count them as equity products. 

Existing in something of a no-man’s land inbetween the two asset classes proves more valuable when it comes to returns, however. The typical convertibles fund outperformed equities but underperformed corporate debt in the final quarter of last year, as you’d expect.

But compare returns with those on high-yield debt, the asset class that they've replaced in certain DFM models, and convertibles’ limitations become apparent. The average fund lost more on the way down last year, and repeatedly trails high yield on the way up, too. Viewed from this angle, the halfway house looks more like an unnecessary complication.

It's perhaps for this reason that DFMs are finding it hard to agree on exactly which convertibles fund is best. The eleven different funds in our database are each held by roughly the same number of discretionaries. The problem may be more to do with the asset class than the underlying manager.

On the charge

The asset management price war, if such a thing still exists, looks rather different from a couple of years ago. Back then all the interest was on headline charges for single-strategy passives. But absent the introduction of the zero-fee funds that are still growing in prominence across the pond, the most competitive tracker fees can fall little further at this point.

More noticeable at the moment are the second order effects: diversified portfolios using these cheaper building blocks to cut their own charges. Much of this is influenced by the continued success of Vanguard’s LifeStrategy funds, available with OCFs of 0.22 to 0.24 per cent. 

Competitors may never have the scale to reach those levels, but they are getting closer: AJ Bell yesterday cut charges for its passive multi-asset funds for the second time in a month, with OCFs now capped at 0.35 per cent. Make no mistake, lower charges for the very cheapest funds will continue to put pressure on diversified portfolios of all kind - be they passive, active or a mixture of the two.