Going steady

Why do DFMs change funds more readily than allocations? One reason is probably reliability: the same sectors have led stock markets higher for some time now, but plenty of managers have found their fortunes shifting nonetheless.

This suggests it’s difficult to find consistent outperformers. And while that remains true to an extent, BMO’s latest FundWatch study points to an unexpected source of durable alpha.

Of the funds assessed in the study over a three-year period, it was US equity standouts that were most likely to consistently beat the competition: nearly a quarter of funds in the IA sector have delivered above-average returns on a rolling three-year basis. That's notably higher than in any other equity or bond grouping. 

BMO’s multi-manager co-head Rob Burdett says the dominance of certain investment styles does indeed have a part to play. In the US, a proliferation of quality growth funds has meant managers are more naturally in sync with prevailing market trends.

For some investors that spells an opportunity to run winners in the US. It also challenges perceptions of a region long regarded as a graveyard for active management.

By the same token, beating peers doesn't guarantee market-beating returns - though our own research has shown that discretionaries' US equity fund selections are indeed flourishing at the moment.

BMO's Kelly Prior notes that "the comfort blanket of central bank policy that keeps investors at the party remains in place", but thoughts are already turning to the future. And that's part of the reason why DFMs are now seeking more nuanced exposure in the world’s biggest equity market.

Tight squeeze

The latest fund manager survey from Bank of America Merrill Lynch paints a slightly better picture than the extreme bearishness in June’s edition. Late-cycle concerns still abound, but investors have nonetheless added to equities and pared back cash and bond holdings. 

Despite the sense that the current cycle might be coming to an end, many of the latest findings could have been published at any point over the past decade without observers blinking an eye. Inflation expectations are at rock bottom; investors are still positioned for low growth and low rates; the proportion predicting value will outperform growth is lower than ever.

Other metrics have a particular end-of-the-affair feel to them: the proportion of investors who think corporate payout ratios are too high has risen to a record 38 per cent. And a record 48 per cent think companies are excessively levered up.

With all this in mind, investors’ decision to return to equities in July is a sign that there just aren’t that many places to go at the moment. But there is one relatively underowned area that has been garnering interest: European equities. 

Allocations to the asset class have rebounded to where they were last September. And in the current environment of relatively muted interest, that net overweight of 9 per cent is now among the most preferred regions.

Inevitably, reasons for caution still remain. There are still plenty of investors faced in the other direction - though buyers might be encouraged by the fact that ‘short European stocks’ is still the fifth most crowded trade cited in the survey. 

More worrying is a look at the European version of Baml’s research. Focusing on European fund managers alone draws out a notable conclusion: the proportion who say that stocks in their region are overvalued has jumped sharply on the month, and now stands at its highest level in more than 19 years. There’s little room for manoeuvre for asset allocators this summer.

Lights flash

Morningstar has delivered another European poser for fund selectors to consider this month. Last week it lowered its rating on a trio of BlackRock funds, including the flagship European Dynamic portfolio, pointing to high turnover in the team as well as increased workload.

That might raise an eyebrow or two in the wealth manager world: European Dynamic is the number one European equity pick among the DFMs in our fund selection database. But Morningstar points to a series of reshuffles on what is admittedly a large team as the principal reason for its waning enthusiasm. 

The fund’s performance has raced away again this year after a difficult 2018. Add to that the continued presence of Alister Hibbert and it’s hard to see discretionaries turning away in any real volume. But as shots across the bows go, the downgrade is one that’s worth considering.