In the huddle

It's still plain sailing for risk assets at the moment, and now there's more evidence that the recent turbulence wasn't all that bad either. Figures from FundCalibre, assessing firms by their funds’ collective track records, found that five of the top ten groups in 2017 managed to retain their places last year. That chimes with our own work on consistency, which showed that plenty of DFM favourites held on to their relative returns even as markets whipsawed at the end of 2018.

But performance figures also tell some less positive tales over recent times. We’ve discussed in the past how wealth managers’ fund picks tend to outperform. What we haven’t yet examined is whether they really stand out from each another. On this front, the findings are equivocal at best.

To look at the dispersion of returns more closely, we’ve taken the ten most popular equity funds in each of four different regions - the US, Europe, Japan and Asia ex-Japan - and measured their medium and short-term performance. In the US, Japan and Asia, three-year returns for half of those funds are within ten percentage points of one another. In Europe, seven out of the ten are in the same boat.

And few funds in any of these sectors stand out at either end of the scale. Yes, the likes of Baillie Gifford American and Miton European Opportunities have roared away, while the more defensive Stewart Investors AP Leaders or Fidelity America Special Sits have lagged. But the remainder sit much closer together.

There’s an argument that this level of bunching is to be expected in the era of cheap money: the rising tide has ensured most funds have bobbed along equally nicely in recent years. Yet the clustering effect is also evident on a six-month view - a period in which volatility returned with a vengeance.

And we should also note that these are among the best funds in the asset class. Sector average returns sit outside the tight-knit groups mentioned above, suggesting there are plenty of funds that don’t behave the same. So one conclusion to draw is that while DFMs’ selections tend to outperform, they do so in very similar ways. Chalk one up, perhaps, for the importance of asset allocation over fund selection.

Orphans and zombies

Wealth managers aren’t alone: differentiation is becoming a growing challenge in all areas of the investment industry. It's becoming a particular problem for asset managers, given the cost pressures coming to bear on their businesses.

Two pieces of data from recent days emphasise the issues they face. For starters, consulting firm Zeb has found that 30 of the 46 largest fund houses are “struggling with high costs or below-average growth, or both”, in the words of Ignites Europe.

Some of these firms’ margins have plenty of room to fall, of course. But the return of falling markets - should such developments prove more than an end-of-2018 blip - will concentrate margins, and minds, further still.

The research also emphasises the predicament many providers have got themselves into when it comes to their own product ranges. The bloat of years gone by has translated into funds that are still making money, but which aren’t attracting investment or even performing particularly well.

Morningstar data released this week suggests that a quarter of the 15,000 funds in Europe with five-year track records are “orphaned” products - sub €100m strategies that saw less than €10m in inflows or outflows in each of the last five years. Our own term of choice is “zombie funds” - and on a short-term basis the problem is even more widespread, as we discussed a few weeks ago.

Admittedly, this problem is less of an issue if you think DFMs automatically disregard these products anyway. Even less so if you consider these products are helping subsidise fund firms’ strategies elsewhere. 

But the risks of reputational damage to the industry as a whole, via the retail investors who still sit in such strategies, is very real. And the medium-term consequence of providers feeling the strain - more M&A - definitely won’t be welcomed by wealth managers.

Home is where the hurt is

FCA chief executive Andrew Bailey has shot down Mifid II doubters by saying the new rules are on track to save UK investors almost £1bn over the next five years.

His assessment’s largely based on the effect that “free” investment research previously had on the price of fund firms’ trades. Most asset managers have opted to cover the cost of that research themselves in the new age of unbundling, meaning trading costs have been lowered and savings accrued by the end-investor.

Those comments are unlikely to placate critics who say the rising cost of research makes it harder for smaller asset managers to use it - or for smaller listed companies to get research coverage in the first place. Mr Bailey said evidence of the latter trend has been “inconclusive” so far. 

But what his speech does emphasise is that those who think the UK’s exit from the EU might prompt a rethink of Mifid II et al are misguided. The FCA, after all, was the architect of much of the thinking behind the new rules - particularly when it came to research unbundling. Its stance has frequently proved to be more stringent than those of its European counterparts. Like it or not, there’s no escaping the current regulatory regime.