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Asset Allocator

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How DFMs can dodge buy-list concentration risks; A 120-year high for income investors

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Worlds apart

For all the talk of a new era of deglobalisation, wealth managers have long since preferred to hunt out regional opportunities rather than seek out portfolios that span the entire globe

So moves such as those we reported last week, wherein a couple of DFMs have added new global equity strategies to their portfolios, still tend to be exceptions rather than the rule. While some global funds offer a specialism that’s hard to find in a regional offering, wealth managers typically prefer to do the asset allocation themselves.

But there is one other advantage of global strategies for DFMs. Of all the equity sectors, our asset allocation database shows the concentration of fund choices is at its lowest in the global equity space, as the chart below indicates:

The typical UK growth fund listed in our database, for example, is held by an average of 2.7 different discretionary fund managers. But buy lists are much more varied when it comes to global growth offerings. The typical fund here is held by just 1.5 discretionaries.

This dispersion isn’t simply down to a relatively small number of funds being chosen by a small number of wealth managers - what the graph doesn’t show is that there are as many global growth funds in our database as there are, say, emerging market or Asian equity offerings. Rather it’s the sheer range of strategies available that has seemingly enabled fund selectors to distinguish themselves from their peers.

It’s a similar story in the US, where a vast number of options - and the ongoing quest to find an active fund that delivers - has resulted in relatively high levels of dispersion. Here, though, this is more a function of a few popular choices coupled with a long tail of products held by individual DFMs. The distribution of global equity funds is much more even, in that - Fundsmith Equity aside - there are hardly any strategies that are held in significant numbers.

Pay to play

The increased interest in UK equities seen since the start of the quarter can be pinned on two main factors: the (near-term) removal of the no-deal Brexit threat, and better risk appetite more generally. For many, this upturn in sentiment is still more in the realm of words rather than actions for now: as we noted last week, there’s little sign of a concerted bump to UK allocations among wealth managers thus far.

But as domestic investors, and those whose portfolios increasingly have an income bent, wealth firms will be conscious of another buy signal that emerged at the end of the summer. The equity risk premium has been a compelling data point for risk asset appetite over the past decade, and there are other gaps between UK equities and bonds that have continued to widen in 2019. 

As Montanaro points out, as of September 30 the gap between the 10-year gilt yield and the FTSE All-Share dividend yield stood at its widest ever level: no less than 4.2 percentage points.

That gulf has since reduced as bond yields rise and equity market performance improves: the gap is currently closer to 3.3 percentage points - more of a piece with the average seen over the past couple of years. But even this, by Montanaro’s calculations, is higher than at any point since 1899.

Twelve decades’ worth of data doesn’t mean a buying opportunity in and of itself. And many of the individual yields in the FTSE All-Share will still look too high for comfort from wealth managers’ perspective. But those seeking income have to get it from somewhere, and alternatives can only take up a small part of the slack. In this context, it’s hardly surprising that UK dividends remain a go-to area for DFMs.

Mifid moves

Coincidence or clear evidence of how Mifid II has shifted investor priorities? Data crunched by FTAdviser shows that UK and European investors have withdrawn a net £63bn from active funds since the second quarter of 2018 - in stark contrast to the behaviour seen in prior quarters.

Over the same period, inflows into passive funds are firmly in the black. But it’s probably too early to say whether Mifid's arrival has prompted structurally higher levels of interest in passives - flows were already positive prior to 2018. Redemptions from active funds aren’t being rotated straight into passive products just yet. 

Nonetheless, it seems likely that the more stringent requirements around disclosure, and on costs in general, are having an impact on how financial advisers view their investments. DFMs have passive-only portfolios available to such clients, of course. But for many advisers the answer will be not to switch wholesale into passives, but to seek out lower-cost offerings that still have an active element to them.

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