Asset AllocatorOct 8 2019

DFMs' rush to UK's Big Four accelerates; Valuations cast aside as allocators scale up

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Welcome to Asset Allocator, FT Specialist's newsletter for wealth managers, fund selectors and DFMs.

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Feel the churn

Passive products have long since won their battle for acceptance among professional investors, but contradictory views on how such funds are best used in portfolios are apparent across the industry.

Some advocates now use trackers and ETFs as core building blocks in their portfolios. But a larger proportion of wealth managers, unsurprisingly, say they choose the best strategies on a case-by-case basis. 

Within this latter group there are still those who see passives as products can be bought and sold relatively quickly, and hence most suited to tactical positioning.

To get a different sense of how the DFM world is balancing these differing priorities, we used our fund selection database to investigate turnover levels among discretionaries’ favourite active and passive offerings.

The chart below looks at turnover rates for the five most popular active funds in three different asset classes, as well as the five top passive holdings. We’ve defined those rates as the proportion of holders who have either bought or sold the fund in the past 18 months.

A few findings stand out. In the US, things are pretty evenly matched. Turnover rates for both actives and passives remain low. This is largely unsurprising, given the straightforward progress enjoyed by US equities of all stripes in recent years. That said, we have noted recent signs that DFMs are starting to think more carefully about their US exposures as the bull market matures.

Things are a little different in two other regions. Attitudes to emerging markets have shifted more than once over the past 18 months. At the turn of the year the consensus was that a buying opportunity had emerged. Ten months later and some have already soured on that stance. Here it does appear that passives, in particular, have been used to trade in and out of the region. 

But in the UK, another area on which opinions have differed for some time now, the opposite has happened. Passive turnover rates aren’t much higher than in the US. Rather it’s active funds for which a spike in buying and selling is apparent.

We’ve noted before that UK equity ownership is concentrated around just four portfolios. Yet the vast majority of recent turnover activity hasn’t been existing holders diversifying their exposures - it’s been yet more wealth managers buying into these strategies. UK equity may still be a contested asset class, but active fund favourites are growing ever more popular.

Same again

As the style reversal seen at the start of September continues to fade into the rear view mirror, analysts are becoming more confident in their assertion that it’s back to business as usual for equity markets.

Barclays’ US equity team is firmly in this camp. It summarises the slump for momentum as “an isolated event that lacked a clear catalyst and is unlikely to either gain traction or negatively impact the broader market”. Value stocks’ move in the opposite direction was nothing more than those stocks effectively “coming along for the ride”.

That argument becomes harder to counter with every day that goes by. But a return to normality, if that is the right word, does have repercussions for other parts of the market, too.

Small caps, for example. In the US, smaller companies have materially underperformed their larger equivalents ever since the summer of 2018. That means, according to Barclays, that small-caps’ share of a momentum basket of stocks is now near an all-time low. On top of that, the relative valuation of small caps versus large caps is now at its lowest level since the dotcom boom.

But the lessons of recent weeks don’t suggest this value is about to become unlocked. A recent uptick in performance for US smaller companies was almost entirely due to the momentum reversal, according to the analysts. 

With recession risks looming and small caps “much more exposed” to the trade war, larger companies still look like the place to be. That will satisfy DFMs for whom overseas small-cap exposure is still, after all these years of diversifying equity exposures, a relative rarity.

Digital fitness

Wealth firms will know that their online propositions now form a vital plank of their services to clients. They could hardly claim not to, given the almost daily insistence that digital strategy must be at the top of CEOs’ agendas.

This is, of course, a forward-looking policy. The client of the future will expect much more online access than many of the current cohort. A survey from fintech firm Nucoro underlines this: its poll of 1,000 retail investors found more than a fifth had claimed to have stopped using a wealth manager because of a weak digital offering.

Given how limited client turnover rates tend to be, the use of the term ‘wealth manager’ here may require further assessment. After all, it's a phrase that can capture all kinds of services, robo-advisers included.

But whatever the terminology, one part of the survey stands out: the proportion of those changing services for this reason falls to just 11 per cent for those aged 55 to 64. Consciously or otherwise, wealth firms may be able to rely on this inertia for now. But the growing need for new client acquisition means it won’t be long before those with inadequate services feel more exposed.