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Market neutral misadventure hurts DFMs; The equity funds falling between the cracks

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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Neutral ground

When it comes to absolute return, recent talk - in these parts and elsewhere - has been all about whether or not they proved their worth during a tough fourth quarter. Uncorrelated assets come into their own at such times - but funds ploughing their own furrow don't always work to wealth managers' advantage.

So it's proved with one of DFMs' favourite alternative strategies: BMO Global Equity Market Neutral. The fund posted a healthy 3.5 per cent gain in the final three months of 2018. Since then, however, things have gone awry as markets start to rise: it's down a hefty 12.5 per cent year to date.

The fund manager attributes this fall to factor plays backfiring. Here’s systematic factors head Erik Rubingh:

The risk-on sentiment that has prevailed so far this year has hit two of the five factors we target particularly hard: value and Growth At Reasonable Price. Markets don’t seem interested in valuations at all.

In one sense, then, this is another case of winded value investors. But what are discretionaries doing in response? We've seen before that wealth managers aren't afraid to cut losses when it comes to absolute return. Some have cut exposure to the BMO fund, but that was prior to its turn for the worse. And that turn hasn't got everyone running for the hills. Thesis research head Matt Hoggarth says his firm has been adding to its exposure: 

The recent drawdown has been frustrating, but it’s not out of line with what we might expect from the fund, given its [10 per cent] target level of volatility. When equities and bonds have been performing well, it would be even more concerning if the funds we wanted to be uncorrelated were also rising.

Not all will be happy with this level of volatility, targeted or not. At the moment, the fund still has enough backers for whom its previous triumphs outweigh recent troubles.

Between the cracks

If BMO’s team struggled to time a value/growth turnaround, they're certainly not alone. But add regional asset allocation to the mix and it all starts to make a little more sense.

Investors view the US as their main growth market - providing they can stomach the valuations. Add to that emerging markets as a turnaround play, and UK equities because of the yields - and value - now on offer. 

That leaves one main loser slipping between the cracks. For Tacit Investment Management, which recently conducted an MPS overhaul, a focus on the US for growth and domestic stocks for value means European equities are left out in the cold. Here’s CIO Raj Basra on the firm’s zero weighting to Europe:

We tend to bypass continental Europe because we don’t get any diversification from those assets. The valuations are pretty similar to the US if you want growth exposure. US companies [also] have better growth prospects. You can buy a lot of similar exposure in the UK and Europe, but at cheaper valuations from a value perspective [in the UK]. Europe gets squeezed between two camps. 

The average Balanced portfolio in our database has 5.6 per cent allocated to the region. But as we've noted, that weighting has been falling back in recent months as a slowdown takes hold on the continent.

That said, falling bond yields have started to change the equation again. Argonaut fund manager Greg Bennett says that the gap between European dividend yields and those on bunds is nearing a ‘historic’ high. That could lend some structural support to continental stocks – and DFMs clinging on to European allocations.

Crowding round

UK robo-advisers and their ilk have long found funding easier to come by than customers, not least in the case of the sector's poster child Nutmeg. Its five funding rounds have gradually started to bear fruit, but it remains a loss-making business for the moment.

Today brings a new twist: the FT reports the company is to turn to crowdfunding for its next cash injection. That's not a bad idea, given the recent success achieved by the likes of mobile bank Monzo. Crowdfunding typically engenders a greater sense of loyalty among backers - and will probably encourage them to put a greater share of their wallets into the firm's portfolios, too.

Still, it's far from a magic bullet - which is perhaps why Nutmeg is also now aiming to generate half its future revenues from licensing its services to banks and other firms. This isn't the end of the great robo experiment - but it's another sign that disruptors don't always have things their own way.

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