Switching it up

A post-Mifid II world, in which fund transaction costs are front and centre like never before, has done little to boost the popularity of portfolio churn. Fund managers have always talked a good game on this front; nowadays it's much easier to see if their money is where their mouth is.

When it comes to wealth managers' own buying and selling decisions, the money is indeed staying put, by and large. Our database shows little sign of the average discretionary constantly adjusting their portfolios.

But all DFMs would agree that turnover isn't a bad thing in and of itself. Sometimes conditions will require relatively quick-fire changes - and some strategies lend themselves to these practices more than others. 

The 8AM Clever model portfolio range, which uses a quant-driven process to implement fund switches, is one such strategy. The firm says its average number of portfolio switches comes in at between six and eight a year. Our database suggests the quant strategy has few qualms about buying a fund one month and selling it soon after; the company notes that its average fund holding time is 14 months.

That’s something that would make more cautious investment managers uncomfortable – but Clever Adviser argues responsive fund switches come with fewer drawbacks than some may think.

For one, the firm notes that the majority of platforms it uses don’t charge for fund switches. It adds that its system ensures any recommendations made by its process are “suitable for the proposed fund flows relative to the fund size”, and says:

Aside from outperformance, because the system is driven exclusively by technology and rational algorithms, financial planners benefit from being able to demonstrate a much more consistent, robust and repeatable investment process – ticking some of the boxes relating to Mifid II.

It's hard to see frequent fund switches ever becoming the strategy of choice for the average fund selector. But the rise of automated processes could yet end up shifting the dial, even as most buyers continue to sit on their hands.

High spirits

Building a bearish case for high-yield debt looks particularly easy at the moment. Concerns about corporate leverage and stuttering growth - in the US and globally - are on the rise, oil prices have fallen into a bear market again, and risk assets are starting to wobble.

In truth, the junk-bond bears have never lacked a narrative, even in times of plenty. Ultra-low default rates over the past decade have left many awaiting a mean reversion which is still yet to arrive. Incidents like the suspension of the Third Avenue credit fund have similarly come and gone with little wider impact.

As we've discussed in the past, wealth managers still have ample exposure to the asset class themselves, though this is often via strategic bond funds rather than dedicated strategies. That additional layer of protection is wise, given the way in which high-yield headlines tend towards the dramatic.

Why the constant concern? Fund flows may be at fault. Of all markets, it's arguably high yield in which the rise of short-term ETF trading has become most notable. That can mean record inflows one week followed by record outflows shortly after. The volume of short-term money is such that the sector is rarely out of the spotlight.  

From UK DFMs' perspective, the reality is rather more mundane. In keeping with other asset classes, outflows from HY retail funds persisted throughout the first quarter of 2019, but the speed was closer to a dribble than a flood. Strategic bond strategies continued to take in money during that time.

And while correlations between high-yield debt and equity markets are particularly elevated at the moment, that's not translated into a material issue for UK fund buyers. FE data shows that while equities stumbled in May, the typical high-yield fund - be it US or European-focused - did little worse than the average corporate bond strategy. Discretionaries' relaxed attitude to the asset class looks justified for now.

Stable doors

Calls for a rethink of how open-ended funds operate are inevitably on the rise again as Neil Woodford fights for his career. The FCA, in breaking ranks yesterday, was at pains to point out that suspension is "not an outcome it seeks to avoid". That was the same message it relayed in the aftermath of the property fund gatings in 2016. 

But while its characterisation of such a move as a "legitimate" measure is entirely accurate, the events of this week also underline the inherent weaknesses of the process. 

The regulator is among those to have called for greater transparency, and better ex-ante communication, about the gating tools a fund manager has at their disposal. Yet all the financial education in the world can't override the emotional and behavioural response to being told you can't (yet) have your money back. 

Amid all the drama, it's worth pointing out that the FCA itself is yet to respond to the results of its illiquid asset consultation that closed in January. A hasty rewrite of its forthcoming policy statement may be going too far. But a relaxed attitude to gating should be weighed against the reputational risks that rise each time a fund shuts its doors.