Pressure points

The shrinking UK stock market suffered another blow in the third quarter, when listings notched up their quietest quarter in a decade. This time round, even investment trusts weren’t immune: total capital raised was a third lower than for the same period last year, according to Numis.

That, however, looks like a temporary aberration. IPOs may still be struggling, but issuance is more than compensating. Fundraising as a whole is 20 per cent up year-on-year for the first nine months of 2019.

The driver of such activity remains wealth managers’ demand for alternative assets. But there are a couple of questions to be asked about one of the most popular asset classes: infrastructure.

Those queries shouldn’t be overplayed at this stage. Amid widespread concern about where to allocate, infrastructure is still ticking most boxes for selectors able to make use of trust structures. Funds continue to offer high yields, a relatively low correlation to equity markets, and, in many cases, an ESG-friendly approach.

On the other hand, premiums to NAV are still elevated, and near record highs for several renewable offerings. And with demand still thoroughly resilient, the investment opportunity set is starting to become a little more constrained. As Winterflood put it last week:

We note the comments by some of the leading investment teams in the subsector about the decline in attractive opportunities in the UK marketplace and the resultant need to invest overseas. While this makes sense, we believe that risk/return profiles of many funds will evolve in time as a result.

It’s a familiar story: being pushed to take on more risk in order to maintain returns. Nonetheless, those consequences might give discretionaries pause for thought.

Long haul

From the opportunity cost of stepping back from equities, to a relative lack of convincing diversifiers, shifting to a risk-off approach looks more complicated than it has done for some time. That's meant some DFMs have instead taken opportunities to ease off the gas where they can find them.

For Heartwood Investment Management, this has in part involved a focus on simpler methods. As investment director Graham Bishop notes, the firm pulled back its overall equity exposure in August on the back of fresh trade war concerns. But this was executed via a “global bucket”, spanning the firm’s full risk asset exposure, rather than anything more complicated. That's in keeping with other recent examples of wealth managers turning to cash. 

However, Heartwood has taken more unusual steps on the hunt for insurance, by picking up long-dated puts on various assets when these looked cheap earlier in the year. While Mr Bishop acknowledges there is a “bleed” here in terms of cost, it’s one reliable defence against a market fallout:

If we get a black swan event or recession or some misstep by a policymaker…that will start to pay off. It eliminates or offsets large swathes of our equity exposure that we won’t be able to get out of as quickly as we would like. In basis point terms it’s small but it’s very geared. Those bps can turn into percentage points really, really quickly.

Mr Bishop is not alone in turning to options – Rathbones’ multi-asset team among others have been turning to equity puts. But what’s interesting is the scope of use here: the Heartwood team is using puts that apply not just to equities but to the likes of other assets including currencies. And “long-dated” translates into years rather than months.

Small comfort

As 2019 has progressed, it’s become apparent to many that UK small-cap funds have avoided the bleakest post-Brexit predictions of their fate - and have done rather well instead. As of the three-year anniversary of the referendum, UK smaller companies funds were the best performing sector in the entire IA universe.

That acknowledgement hasn’t translated into a spike in fund flows - as ever, there’s more Brexit uncertainty right around the corner - but it has given buyers something else to think about.

This week, however, the pendulum has swung the other way again. Standard & Poor’s bi-annual Spiva scorecard of active management performance, published on Tuesday, did note small-cap strategies’ success over the medium term. But it also emphasised that the active approach has started to go into reverse: small-cap funds have lagged the S&P benchmark by 3.7 per cent in the year to June 30, 2019 on an asset-weighted basis. The sector’s moment in the spotlight may ultimately prove shortlived.