Closed minds

Conventional wisdom dictates that providers shutting funds rarely presents a problem for wealth managers. It’s typically only sub-scale strategies, often underperforming ones at that, that suffer the axe. But a new spirit of vigilance could end up hampering DFMs’ attempts to diversify.

Size is a factor in discretionaries' fund-buying decisions, but in the investment trust space that’s often less of a consideration. And it’s here that boards are starting to clamp down quickly when returns start to falter.

A recent example is AEW Long Lease Reit. Far from a mainstream offering, but one that is held by a handful of wealth managers via either unitised funds or bespoke portfolios. The trust’s board said last week that it was considering winding up the portfolio in light of its poor performance and the news that its largest tenant had gone into administration.

This AEW offering is smaller than most peers in the sector - the board acknowledged size was also an issue - but its other characteristics are shared by several other trusts. A current discount to NAV of 7.6 per cent is far from unusual across the physical property sectors; many others are similarly out of favour.

The issue, for DFMs, is that this unpopularity is part of the reason why they hold such strategies. Our own research has suggested that sell decisions are more commonly due to excess returns than significant underperformance.

After all, it's inevitable that certain asset classes will outperform others at given parts of the cycle. And the trends that first emerged in the early days of the post-crisis rall, ie investors’ preference for growth and quality income, have persisted longer than anyone expected. 

Physical property has had a more volatile journey, but there will undoubtedly come a time when it flourishes again - in the closed-ended sector, at least. Wealth managers will hope that investment company boards’ newfound vigilance is limited to idiosyncratic cases like AEW Long Lease, rather than evidence of a zero-tolerance approach to underperformance.

Dividends deliver

Backing UK stocks has paid off in the most literal sense: the opening quarter of 2019 saw dividends from the domestic market rise by 15.7 per cent on a headline basis, to a Q1 record of £19.7bn. It’s further reassurance for the many DFMs who are still backing UK income funds despite other misgivings about UK equities.

But as ever, there’s more to this than a story of easy wins. For a start, much of the headline increase in Link Asset Services' UK Dividend Monitor is owed to special dividends - notably a “huge” payout from BHP - with underlying growth actually falling short of original expectations. And in what has long since become a weary positive of political turmoil, dividends also benefited from exchange rate movements.

Wealth firms would do better to bear in mind a couple of main factors. Yes, even with markets looking steadier, UK equities are expected to yield some 4.8 per cent over the next 12 months.

But here come the caveats: this figure applies to the top 100 payers. Mid caps, which have contributed less significantly to the most recent figures, are expected to yield just 3.1 per cent over the next year. There’s a suggestion that some popular small and mid-cap names among DFMs’ top UK equity income picks could lag behind, though that’s unlikely to dissuade wealth firms keen for some diversification.

And diversification may rise even higher on the agenda, given concentration risk has shown no sign of waning: the top five payers represented 51 per cent of dividends last quarter, up from 46 per cent a year earlier. 

Little consolation

The latest study from BMO is more evidence that fund managers’ relative performance improves when markets are rising, not falling. The firm’s FundWatch survey found 2.2 per cent of funds had produced top-quartile rolling three-year returns by the end of the first quarter. Not exactly a badge of honour, but well in excess of the 0.54 per cent who held such status at the turn of the year.

One consistent theme to come from the consistency research is that the UK small-cap sector is among the most reliable: it’s topped the pile for each of the last three quarters, and off and on for years prior to that. But wealth managers have other ideas, judging by our database: fund selections down the cap scale are among the most disparate of them all.

That may simply be because smaller companies are out of favour: DFMs are searching hard for different strategies at a tough time for the asset class. This is arguably one case where they should stick with what they know.