Test cases

With cost pressures on the minds of DFMs and their customers, passive-only wealth portfolios are becoming an increasingly important part of the industry's offer to clients. But their success poses questions about how well discretionaries are performing in other areas.

More than one in three wealth managers in our database now have a portfolio range based entirely, or mostly, on passive instruments. And when it comes to performance, there have been plenty of opportunities for either style to prove themselves of late. Trackers have benefited from steady market rises for the lion’s share of 2019, but the market fallout at the end of last year provided an opportunity for active advocates to show their worth. 

As a snapshot, we’ve compared a sample of DFMs’ passive (or predominantly passive) Balanced portfolios with the same firms' active (or predominantly active) equivalents. 

In a handful of cases the passive-leaning portfolio has fallen down: as the left-hand side of the chart shows, three have underperformed their active equivalents, all by at least 2 percentage points.

Generally speaking, however, the lower-cost route has proven most effective: all other passive or blended portfolios have beaten their active-leaning peers.

For some, this might be a warning sign: given DFMs are typically more predisposed to favour active holdings than trackers, their core activity sits in an unflattering light on a one-year horizon.

But any further shift towards lower-cost, passive-heavy offerings might be stymied by concerns over markets' fate in the coming months. Wealth firms' own performance figures might favour passives for now, but some might need more persuasion that the same will hold true over the coming months and years.

Bulwarks

Whatever the impact in terms of returns, it's clear that passives' prominence in DFM portfolios is on the up. And lofty predictions are still being made for their future importance. 

BlackRock - while not exactly an uninterested observer in such things - predicts that the proportion of UK wealth assets held in passives will rise from 20 per cent to 30 per cent in the next two years alone. That’s due to the pressures imposed by the likes of Mifid II, among other factors. 

But there are still plenty of areas within the fund selection universe that remain relatively immune to the charms of trackers and ETFs.

One such area is equity income: hardly a minor part of discretionaries’ asset allocation. As we’ve discussed in the past, there’s been very little sign that the major passive UK income strategies have been capturing more investor attention of late. Overseas equity income remains a predominantly active hunting ground, too.

Outside of income strategies, it's clear that passives have made major inroads into selectors' structural preference for active equity funds. But that's more apparent in developed markets than other regions: Asian and EM equity fund selections still tend to be based on an active approach, for example.

Index-tracking products have made more headway in the fixed income arena, but there are big active bulwarks here too. That’s most notable when it comes to strategic bond funds - none of which are passive in nature. More surprisingly, high-yield debt has also proven a tough nut to crack for ETFs and the like. 

And then there is alternatives: a growing part of DFM portfolios, and an asset class that naturally lends itself to a more hands-on approach. Active-only portfolios may be a thing of the past, but a ceiling could still be in sight for passives if they can’t succeed in breaking the active monopoly in major asset classes like these.

Central criticism

Donald Trump's criticism of Jerome Powell is increasingly looking like a new normal, or at least an act that other countries are looking to follow. A few weeks on from the resignation of a "fierce advocate of central bank independence" at the Reserve Bank of India comes news that president Erdogan has sacked Turkey's central bank governor after a dispute over interest rates.

Such altercations aren't unheard of at times when economic pressures increase. But add the US to the mix, as well as a global economy in which there are few, if any, powerhouses still firing, and the problem becomes more acute. 

Central bank independence is not an unshakeable tenet of modern politics, and the events touched upon above could yet be seen, in hindsight, as the start of a wider shift in mindsets. For those running portfolios, that might mean another reason to think more carefully about the likelihood of an end to the era of ultra-loose monetary policy.