Regional divides

With 2019 nearing its midpoint, DFMs are getting a clearer picture of how their asset allocation calls are playing out. Look at equity indices and it's clear that the US has reasserted its dominance, Europe is confounding some doubters, and the consensus call of the year - emerging markets - has yet to truly excel.

Discretionaries' own perspective is a little different. We’ve previously discussed the fact that strategies backed by DFMs tend to do better than the wider fund universe. But, in a year when many risk assets are moving higher in tandem, that outperformance can lead to some surprise winners.

Our chart below gives a year-to-date snapshot of how DFMs’ top picks have done against commonly used indices.

The global funds most widely held in model portfolio ranges slightly lag the MSCI World benchmark, but elsewhere DFMs’ favourite names have, on aggregate, beaten their indices.

Nonetheless, it's notable that DFMs' European equity picks have outstripped even US funds this year in sterling terms. This at a time when many wealth managers have been cutting back on allocations to the region.

Emerging markets are another major standout. In 2018, this was a region where DFM picks tended to struggle versus peers. This year the top 10 have raced past indices in Japan and the UK, despite benchmarks in those regions having outperformed the MSCI Emerging Markets.

We can see the same dynamic at play, albeit to a lesser extent, in Asia. It's another reminder that while asset allocation is often tipped as the chief driver of returns, time spent on fund selection is far from wasted.

Liquidity flap

As anticipated, the FCA’s delay in finalising a response to its illiquid asset paper has come in handy this month. The regulator’s chief executive Andrew Bailey, writing in the FT, says it will take into account the lessons of the Woodford affair before publishing its findings.

And yet, as we also indicated last week, sweeping changes to the funds regime are unlikely. That’s partly because one potential target of Mr Bailey’s ire - the 10 per cent illiquid asset allowance - is a Ucits rule rather than a domestic regulation. 

What's more, the big levers that are accessible to the FCA are unlikely to be pulled. There’s nothing in the Ucits framework that says a fund has to offer daily dealing, but the regulator will recognise this is an investor demand rather than an industry standard imposed from above. And, to be fair, it seems unlikely that fortnightly dealing (permitted by Ucits) would have altered the eventual outcome in Mr Woodford’s case. 

When it comes to illiquid investments in general, Mr Bailey’s comments also emphasise the watchdog remains open to their merits. 

That leaves the second-order issues like the role of fund distributors. There have been calls for a crack down on D2C platforms’ best-buy lists, but to do so shortly after the FCA gave the sector a relatively clean bill of health would prove a little embarrassing. 

Ultimately, although the Woodford saga remains a serious reputational problem for active management, wealth firms aren't viewing it as a systemic issue. What may happen is that ongoing migrations start to accelerate. There's long been talk of firms making greater use of segregated mandates, though this shift has stalled a little in recent months: Brewin’s model portfolio changes have not been mimicked by a swathe of its peers. For DFMs, the lesson of the past few days may boil down to the need to retain absolute control over their investments.

Holding pattern

Domestic dramas aside, last week was a rather better one for risk assets. The outlook improved further over the weekend with the news that the trade tensions between the US and Mexico have been set aside for now. 

This, admittedly, only puts investors back to where they were a couple of weeks ago. It will be a while  before any clarity emerges on the bigger trade pinch-point; analysts are now looking to the June 28-29 G20 meeting as a potential breakthrough moment in US-China talks - a hope rather than an expectation, admittedly.

In the meantime, some indicators are still flashing amber. The renminbi continued to fall even as risk assets rallied overnight, though the suspicion is that it too will prove range-bound until the end of the month. The midpoint of the year could yet prove to be a fulcrum around which returns pivot in 2019.