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Asset Allocator

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Selectors' slow creep to a portfolio tipping point; Betting against the alpha generators

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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Ballast or balance

If more difficult times lie ahead for markets, it feels unlikely that DFMs will make a sudden charge for greater passive exposure across the board. But current active/passive blends are far from uniform when it comes to the various nooks of the investment universe: discretionaries tend to lean in different directions in different areas.

With that in mind, we’ve expanded our recent analysis of the active versus passive mix in Balanced portfolios. This time, we’ve looked at European, Japanese and global equity funds, as well as corporate bond products.

The chart below categorises each asset class by how much exposure they have to actively managed strategies:

The chart suggests wealth managers have a similar view on corporate credit as they do on government bond funds: many prefer to rely on cheap, vanilla exposure as the building blocks of their portfolios, rather than taking a risk on those picking individual bonds.

Elsewhere, it's more of a 50/50 split: In the case of global equities, this is partly a reflection of wealth firms’ reluctance to delegate decision-making to global managers. Those who do go global often do so by adding some ballast to their portfolio via a world index tracker. 

Japan selections are also split relatively evenly - which puts the region slightly at odds with its European counterpart. Big-name managers are popular in both sectors, but it's Europe where discretionaries have more obviously avoided a slow creep towards trackers: nearly half the portfolios in our sample have no passive exposure to the region.

That may be a reflection of a two-speed Europe; it's also an indication that stockpickers have delivered the goods for DFMs in recent years. There's no watershed moment for them just yet.

Beware market darlings

The world of active management is built on the belief that markets are inefficient. But sometimes those inefficiencies can play out in ways that don't exactly help the average fund manager. "The market can remain irrational longer than you can remain solvent" is only the most obvious example. 

Now a new paper has suggested that even managers who effectively exploit inefficiencies end up paying the price. The problem stems from a familiar issue for wealth managers: crowded trades. 

As Bloomberg reports, the paper suggests the capital asset pricing model has simply been too successful: too many investors identify the same "good" stocks (as judged by historical returns) and shun the same "bad" stocks. And this doesn't even result in prices ultimately evening out: the weight of money chasing the good shares is such that their valuations ultimately overshoot on the upside, and vice versa for bad investments.

The paper's author, Alex Horenstein, describes his findings as follows: "I find that assets with low alphas have higher ex-post average returns and Sharpe Ratios than assets having high alphas." He then points to a "betting against alpha" long/short strategy. 

The whole thing is simply too counter-intuitive to ever be officially adopted by fund managers - it would take a truly brave investor to pitch such a strategy to clients or indeed their own bosses - but you can see echoes of it in some contrarian or even value-oriented styles. 

For wealth managers, a more significant finding may be the way that smart beta strategies, allowing investors to target specific factors more effectively, have exacerbated the problem described above. Identifying shares that are shunned by such processes - like looking for funds that are absent from rivals' buy-lists - may be a path to success in future.

Earning their keep

With the major macro events of early 2019 - the Fed pause chief among them - now thoroughly digested by investors, attention turns to Q1 earnings season, which kicks off tomorrow in the US. The prognosis is gloomier than it has been for some time, but it's the reaction that's up for debate.

The FT notes that expectations are for S&P 500 earnings to decline 4 per cent year-on-year, the first contraction since 2016. Revenue growth is similarly expected to come in at the weakest level for almost three years.

The optimistic case is that these figures have already been priced in: a strange thing to say, perhaps, given the rally seen since the start of the year. But that was driven by expectations of looser monetary policy rather than optimism on earnings. 

The other side of the coin is that it’s the guidance for the months ahead to which investors will really be paying attention: downbeat outlooks could be the issue to emerge from the next few weeks. All that said, the lesson of the last few years is that it takes more than subdued corporate results to derail the bull market.

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