The illusion of choice

A desire for diversification means alternative fund options are never far from DFMs’ minds these days. And fittingly enough, there’s little consensus on what constitutes the best fit.

Alts make up just 10-15 per cent of an average portfolio, yet our fund selection database shows discretionaries are holding more than 150 different strategies within this bucket - and that’s not including the likes of property, infrastructure or commodity plays.

This dispersion has increased over recent months as some former favourites start to struggle. Bigger names have underwhelmed, and that means wealth managers are having to think harder about how to diversify.

Those 150 names have been filtered down from a much larger universe of potential choices. Some investment managers, however, suggest the pool of viable options is considerably smaller than it first looks.

As a starting point, Morningstar lists over 2,600 liquid alternative plays available to European investors. But the firm’s investment team note that screening for those with a track record of more than five years cuts this list in half. Take out non-Ucits options, those with less than €100m in assets, and strategies that have posted a negative return over the past three years, and the total number falls and falls, to a final level of 140.

This isn’t to say that DFMs in our database have already exhausted all available alternatives: many will be content to disregard some of the screens listed above if the right fund comes along. But it does underline the challenge facing allocators in their quest to add something different to their portfolios. As in other asset classes, a proliferation of funds doesn’t always mean wealth managers are spoiled for choice.

Balancing act

The first day of the final quarter of the decade began with one notable data point hitting a 10-year low. Underwhelming US ISM manufacturing figures were enough to send risk assets into the red yesterday, and raise further questions about the health of the global economy.

A pullback for US equities was arguably on the cards: the S&P 500 posted its biggest year-to-date gain for two decades over the first three quarters of 2019, and has already begun to lag other regional indices over recent weeks. Still, as we detailed last week, plenty of UK discretionaries have responded to this year’s jump by doubling down on US equity exposure within their portfolios.

Negative yields elsewhere mean the US is also continuing to dominate fixed income market activity. The bond rally may have eased slightly in September, but last month was nonetheless a record one for corporate debt issuance - and one dominated by US firms.

In many cases this debt was used to bolster balance sheets rather than lever up. Companies are preparing for tougher times ahead, though wealth managers will be forgiven for thinking they’ve heard something similar for several years in a row now. But there are surely limits to how long a ‘Goldilocks’ scenario can continue to play out in investors’ favour. 

This not-too-hot, not-too-cold balance is best illustrated by the value of the US dollar. Any further increase could well start putting pressure on US corporates. A reversal - as agitated for by a US president who could yet take matters into his own hands - would have a significant impact on innumerable investment strategies. DFMs will be hoping things remain just right for a while longer. Still, there’s reason to think other equity markets are now looking a little more attractive.

Scaling back

It’s not controversial to note that consolidation has accelerated in the DFM space this year. UK fund managers also continue to join forces, particularly at the smaller end of the chain. Yet when it comes to M&A, the most consequential forecasts still tend to be reserved for the adviser space. To that end, a study published by Canada Life this morning found that a third of financial advisers are considering selling their business.

The finding isn’t out of keeping with recent research from the likes of Octopus and others. And while the adviser market has been notable in its resilience of late (the total number of firms has barely moved in recent years, according to FCA figures), this may be in part because small businesses swallowed up by networks are continuing as appointed representatives for now. 

If a tipping point does eventually arrive - driven by an ageing industry and the knock-on effects of the defined benefit transfer clampdown - it will have an impact on discretionaries. True, those fighting for adviser clients may be the beneficiaries of advice firms feeling too overburdened to conduct investment business themselves. But a smaller advice industry could ultimately mean a smaller DFM sector, too.