Too good to be true

UK retail fund sales have notched up another month of improving fortunes - but DFMs aren’t joining the celebrations.

A second consecutive month of inflows for retail funds in May saw a net £1.3bn invested, with UK equity funds enjoying their first net inflows since April 2017. Wealth managers, however, have continued to withdraw money, according to figures released yesterday.

After a brief resurgence in April, when discretionary managers broke a seven-month long negative streak, DFMs’ net purchases of retail funds returned to the red in May.

It’s particularly significant that this happened when other parts of the retail investment world were in a pretty positive mood. May was a volatile month for risk assets, but fund platforms and both onshore and offshore financial advisers all recorded significant net inflows.

For UK advisers, in fact, May was the best month for retail sales since January 2018. Add together all segments of the market, and the Investment Association figures show May was the second-best month in the past year. 

That leaves the question of why exactly DFM flows continue to buck the trend. It may be that wealth firms are naturally more cautious than their adviser peers. Alternatively, outflows from DFM propositions may be to blame - though clearly the two theories aren’t mutually exclusive.

The data also confirms the patterns we reported last month: tracker funds had their most successful month ever, notching up £2.3bn in inflows, while the inexorable rise of Fundsmith Equity helped the Global equity sector retain its place as the most popular fund grouping. Both those trends will chime with many discretionaries’ own thinking - but prudence, or portfolio pressures, are obliging them to hunker down for now.

Too big to fail

A two-speed market has been a feature of equity investing for many years now. The most obvious example is growth versus value: investors’ preference for the former over the latter has persisted for the past decade. Occasional flickers of resurgence for value stocks have quickly been snuffed out.

Lately there’s another split that’s started to assert itself: mega-caps over the rest. SocGen analysts have noted that equal-weighted indices have slumped this year as well as last, even as regular benchmarks make new highs. Grouping 17,000 global stocks into four groups based on size, SocGen finds that only those with market caps of $100bn plus have really recovered from last year’s slump. And the problem seems to get worse lower down the cap scale.

The bank summarises: 

Our increasing focus on a few large cap indices populated by just a fraction of the world’s companies is giving investors a false impression. Corporates are struggling!

A microcosm of that trend can be seen in the UK - when it comes to profits, at least. Big businesses are continuing to perform, but the rest saw a sharp fall in revenues during the first quarter. 

We shouldn’t forget that domestic small-cap funds have been holding up pretty well in terms of stock market performance. But SocGen’s figures suggest that smaller companies aren’t proving particularly adept at holding the line elsewhere.

DFMs won’t be too fussed at that, given their relative reticence at backing such strategies. Of greater concern is the mega-cap surge: as we’ve discussed in the past, most active managers are structurally underweight this segment of the market. Direct stock picking or backing a passive strategy look like the only ways forward for wealth managers looking to capitalise on this trend.

Aiming high

A review of inheritance tax rules ordered by the chancellor has arrived: its conclusions will mostly make for pleasant reading for wealth managers, but one surprise warning shot has been fired, too.

The Office for Tax Simplification’s report, its second on the subject, features a series of recommendations that include cutting back the ‘seven-year rule’ for passing on assets to five years. As the OTS’s name suggests, most its proposals are aimed at disentangling various knots in the system. But its thoughts on Aim investing could ultimately make life rather complicated for DFMs.

In a section entitled “Is the treatment of Aim shares within the policy intent of Business Property Relief?”, the advisory body questions just that. It emphasises that BPR is “not necessary to prevent the business from being broken up or sold in order to fund the payment of inheritance tax” when it comes to third-party investors in Aim-traded shares. 

Those third-party investors, of course, are increasingly wealth managers and the like: dedicated Aim portfolios, and their associated tax breaks, are an increasingly prominent part of their businesses. 

The OTS stops short of explicitly recommending a crack down on these practices. As it notes, the November 2017 Patient Capital Review saw the government explicitly commit to protecting such reliefs for Aim-listed companies. But there’s no guarantee a new government would think the same.

As the organisation's Bill Dodwell highlighted in comments to the FT, “we think Aim is the only market in the world where investors can receive an inheritance tax benefit”. It might be time for discretionaries to consider the long-term futures of their own portfolios.