Sustainable success?

With a third of DFMs in our database now running portfolios with an ethical or similar slant, the claim that such approaches sacrifice returns has fewer supporters than it once did. But even if the debate has moved on, that doesn’t mean specialist portfolios can be expected to perform in the same way as mainstream offerings.

And these 21st century portfolios don't need to hold the typical 21st century stocks. As we discussed last year, even the US tech giants nowadays might not pass muster in an ESG-themed portfolio even if they're core holdings elsewhere. That can have a hefty effect on returns.

For an idea of whether ethical models are holding their own, we’ve compared their performance with that of the Balanced strategies run by the same wealth firms. The results over a one-year period are below:

As the chart shows, the last year has been kind to ethical approaches: the vast majority of portfolios from our sample are ahead of their mainstream equivalents. But where have they gained the upper hand?

One explanation could come down to the funds ethical portfolios tend to hold. As we noted in January, DFMs with ethical strategies are forced to huddle around some of the same funds in order to meet their criteria. But the most popular strategies haven't exactly blown the lights out: over the year to the end of June, returns from five widely held names mentioned in our analysis range from a 6.2 per cent gain to a 3 per cent loss.

So sector and factor exposures perhaps played a more significant role: ESG approaches, for one, can have a bias towards quality. And as our chart below confirms, the outperformance of these styles is far from a short-term phenomenon.

Tough calls 

With the first half of the year now well behind them, investors might confess to mixed feelings about 2019 so far. Assets have rallied strongly and monetary policy stances have become more accommodative – but much of this seems too good to be true.

DFM portfolios have certainly benefited from the favourable conditions of recent months, but that doesn’t guarantee optimism about the future. For an idea of current sentiment, we’ve analysed the DFM commentaries, as we did at the turn of the year, to shine additional light on their views at the start of Q3.

Markets may have come a long way since the end of 2018, but that doesn’t appear to have altered the outlook for most. As in our last analysis, half of the DFM commentaries strike an upbeat tone. Some of this stems from a belief that global growth looks reasonable, while others cite receding geopolitical risks and a continued “lower for longer” rate environment. As one wealth firm puts it, the end of the market cycle is not yet upon us.

That doesn’t mean an absence of bearish sentiment, with a third of the names in our sample taking a negative view. Some are derisking, with concerns about lofty valuations and impending volatility weighing heavily on minds.

It’s also notable that even the optimists have plenty of caveats. One firm makes the case for a “constructive” position on risk assets but warns that things could easily go the other way. That's further evidence that with many uneasy about this year’s rally, taking a strong view is harder than it once was. 

Under-Fed

The Fed having cut rates roughly in line with expectations, phrases like a “sensible middle ground” have peppered many strategists and fund managers’ snap analysis of last night’s activity at the US central bank.

The market reaction doesn’t tell quite the same story. With equities falling and the dollar rising, financial conditions appear to have been tightened rather than loosened. And this isn’t just a case of ‘buy the rumour, sell the fact’: the Fed’s suggestion that further cuts aren’t guaranteed was more significant than the cut itself.

Jerome Powell et al can’t be blamed for that stance, given opinion is still split on whether the US economy is struggling or not. But it does call into question the point of cutting at all. New York Fed president John Williams was quickly forced to row back on dovish comments made earlier this month, but as Merian’s Nick Wall points out, his original point is worth pondering: “when you only have so much stimulus at your disposal, it pays to act quickly to lower rates at the first sign of economic distress.”