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DFMs isolated as FCA resurrects fund-split idea; Allocators pick sides for next bond battle

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Splitting hairs

FCA head Andrew Bailey's latest comments on the Woodford affair have seen him resurrect one of the watchdog’s more outlandish ideas - separating retail and institutional investors. But wealth managers would be wrong to think the idea has any more chance of success this time around.

The regulator had already made similar noises in its illiquid asset policy paper at the end of September, saying it would look at “whether separate redemption conditions should apply to [large] investors" in funds of all stripes. 

That followed its original February 2017 discussion paper, when it first floated the idea of splitting retail and institutional assets in relation to property funds alone. Back then the FCA did acknowledge there were “less intrusive measures” than creating two separate funds, such as applying different redemption terms to different share classes. That would at least limit one of the obvious problems with the proposal: the potential to usher into existence a wave of sub-scale retail-only portfolios.

Either way, this point of discussion was subsequently dropped - until now.

But however much Mr Bailey wants to investigate the idea, the odds are it will remain purely hypothetical. Attempting to put it into practice, even in a share class format, would be both unfeasible and ineffective. 

For starters, there’s the question of where to draw the line between retail and institutional. The way that money is pooled in the modern age, on platforms and via nominee accounts, makes untangling these knots all but impossible. And this isn’t the only definitional issue to confront.

Defining retail as purely D2C investment would mean advised investors remained at the mercy of institutional decision makers, as the regulator sees it.

But if advisers and DFMs were to fall into the retail category, an end to fund suspensions would be far from guaranteed. It was wealth managers, after all, who precipitated the 2016 property gatings. Wealth firms are the insoluble problem here: they don't fit neatly into either the retail or institutional box nowadays. So when it comes to potential preventative measures, this one is likely to remain pie in the sky.

The short view

Retail investors - however you define the term - continued to pile in to corporate bonds in September. At the same time, some are growing more nervous that the credit party is starting to wind down again.

Pimco CIO Daniel Ivascyn, whose portfolio responsibilities include the GIS Income fund favoured by a handful of wealth managers in our fund selection database, has been cutting back corporate bond exposure in recent weeks.

In truth, this is a story about developed market fixed income of all stripes rather than just credit. Government bonds’ own 2019 rally has been even more pronounced. Discretionaries, as we’ve noted over the past six months, have gradually become happier to buy into this bounce. Asset managers, too, are warming to the asset class again.

On the other hand, yields have bottomed out in recent weeks, and few would count themselves as happy long-term holders of conventional bond funds. For those who still see the need for some fixed income exposure, short-duration strategies remain an obvious middle ground. 

But as allocators weigh up these factors, appetite for the sector has been understandably mixed in recent times. 

What has been unequivocal is the level of turnover in portfolios, according to our database. Almost one in three DFM short-duration bond fund choices have been added to or removed from portfolios since the fourth quarter of last year alone.

Swapping one short-duration strategy for another is a rare event: these decisions typically express an opinion on the asset class rather than an individual fund. And as it happens, exactly half of those wealth firms changing positions have introduced a short-duration strategy, with the remainder opting to remove their exposure. So DFMs are split down the middle for now - but the odds are that more will be returning to the asset class in the coming months.

Dividing lines

The uptick in bond yields that's begun over the past few weeks hasn't attracted much attention, in part because equities have continued to rise. That split has been a good omen for those who are wary of assets moving in correlation. It's also a sign some think better news is on the way for the global economy as a whole. 

So while events like the S&P 500 reaching another record high yesterday are now free from the euphoria that once accompanied such milestones, a sense of positivity isn't entirely absent.

The question for allocators is which sectors, exactly, are going to do the grunt work for the equity market over the coming quarters. But analyst opinion is increasingly split on that front: whatever the outlook for risk assets, investors are no closer to solving the momentum versus unloved stock conundrum.

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