Trailing the pack

The six months since this newsletter’s launch have been a tale of two halves: first a market in freefall, and then a rebound that continues to this day.

And as mentioned earlier this week, despite providers' insistence that their active strategies can outperform in falling markets, there are signs that the Q4 slump did little to help their cause.

With that thought in mind, we’ve returned to a similar theme of our own. The chart below shows how DFMs’ top 10 fund picks in given areas rank, in terms of performance quartile, for the three years to the end of March. 

True enough, there is more red on the chart this time around, indicating more top picks are struggling to stand out. The most obvious change is in Japan, where the number of outperformers has tumbled from nine to just four. While the likes of Baillie Gifford and Lindsell Train have held up well, other favourites fell back against peers.

There are some bright spots: in the UK, the vast majority of the top 10 picks are well ahead of their sector average. In the US, we’re again looking at a 50/50 split between those leading the pack and those lagging behind. 

But when it comes to global equity picks, the number in the first quartile has slumped, with three funds now in the bottom quartile. Some single-country funds have also taken a hit: in the US and Europe, more funds now sit in the fourth quartile. DFMs don't need - or want - all their equity selections to outperform at the same time, but the findings suggest they shouldn't assume everything's now back to normal after a dramatic six months.

Faltering factors

This week marks 19 years since ETFs first landed in Europe. Spring 2000 also saw the launch of the first smart beta products in the US - but unlike their mainstream counterparts, there’s little sign factor investing strategies have come of age for UK wealth managers.

We’ve documented passives’ growing prominence on discretionaries’ buy lists in a variety of different ways over recent months. But the same trends don’t apply to smart beta.

Our fund selection database shows that factor-based strategies account for 13 per cent of all passive equity holdings. Not so bad, you might think, and broadly reflective of the market as a whole. 

But the problem arguably lies in the way these allocations are held. Of all the smart beta equity products used by wealth managers in our database, just one - the SPDR US Dividend Aristocrats ETF - is held by more than a single DFM.

On one level, this is promising stuff: FTSE Russell’s most recent global survey of smart beta investors found that capacity concerns, ie the fear that growth in a given strategy may hinder its ability to produce the right kind of return, were cited as an issue by a third of respondents.

But there's a balance to be struck between too large and too small, and right now the problem is still that too many products are failing to reach critical mass.

As the paradox of choice puts it, more is less and less is more. The surfeit of products doing very similar things - albeit sometimes with different unintended biases - means a mass cull must ultimately be on providers' agenda.

Switching between smart beta products is cheaper than doing so on active equivalents, but that doesn’t mean a wave of closures would prove trouble-free for discretionaries.

Mean reversion

Some good news to conclude, sort of: the latest Baml fund manager survey, out this morning, reports another sizeable rebound in growth expectations. Only five per cent of investors now expect global growth to weaken over the next 12 months. That figure stood at 60 per cent as recently as this January: the rapid turnaround represents the biggest three-month jump since 2012.

The check to this optimism is that it all looks very much like mean reversion. Despite the market recovery, the net proportion of investors who expect higher global inflation over the next year has "stalled" at just 32 per cent, down from 70 per cent last November.

Further confirmation that escape velocity remains way off comes from the proportion expecting both growth and inflation to stay below trend. This figure has risen consistently over the last few months and now stands at some 66 per cent. 

That's the highest level since October 2016 and, as Baml says, confirms that secular stagnation is once again the consensus view. A Goldilocks economy has been good to investors, of course, but will do little to limit the political risk that's increasingly started to impact markets over the past few years.