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Asset Allocator

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Fund stragglers and the zero-tolerance approach; DFMs take the fight to Vanguard

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Zero tolerance

From government bonds to risk assets, 2019 was – with the benefit of hindsight - a good year to run winners. But a year of extreme market gains brings its own difficulties, particularly when it comes to choosing the best funds.

On the other side of the coin, how has this affected discretionaries selling down holdings? With that question in mind, we’ve analysed those funds dropped by DFMs in our MPS tracker over 2019, noting their relative performance in the year prior to sale. The results are below:

The chart suggests that, with markets racing ahead in 2019, DFMs have generally been unwilling to tolerate underperformance. Nearly 40 per cent of funds sold down had spent a year in the fourth quartile, with some 60 per cent of dropped holdings having lagged peers.

If this seems like common sense, it has not always been the case. We noted early last year that DFMs had been as likely to sell their best performers as call time on struggling funds, with the largest proportion of ejected funds sitting in the first quartile over the previous year.

Part of this shift may stem from those DFMs looking to use fewer funds and focus on their best ideas, but market returns also have a lot to answer for. A market surge has made it harder for active names, including DFM favourites, to outperform benchmarks, but also shines a light on those lagging their peers. And in the post-Woodford era, closer scrutiny of professional fund selections will undoubtedly focus minds.

More or less

A year of market gains across the board is, inevitably, good news for passive-heavy portfolios. But DFMs running such strategies should benefit from more than just a year of hefty returns.

Lower costs and the client demand this might attract are hard to ignore, but there’s also a more prosaic appeal in running a portfolio that is at least mainly focused on passives. For an investment manager it should simply mean less work, with less onerous fund due diligence requirements and fewer holdings to monitor.

As a test of the latter theory, we’ve looked at a selection of DFMs who run passive Balanced portfolios alongside the active versions and compared the two by number of holdings.

The results, in many cases, are as some might assume. DFMs in our sample tended to have around 25 to 30 holdings in the conventional Balanced portfolio, with some 10 fewer funds in the passive equivalent.

But some are much closer in size: one firm’s Balanced portfolio came with 22 holdings, with just three fewer names in the passive counterpart. In this case, the active strategy arguably looks more concentrated than its lower-cost sibling.

What’s also notable is the level of diversification on display in the passive-oriented names. The least populous example held 14 funds, while the highest number of holdings came to 21. This suggests that DFMs are offering much more than base exposure to the main markets. It’s an approach that offers similar exposures to those in the active strategies, but also differentiates passive wealth portfolios from the likes of Vanguard’s LifeStrategy funds.

Sustainable growth

Developments at the world’s biggest asset manager are often instructive, even if they reaffirm existing trends. So it’s notable to see BlackRock kicking off 2020 with a renewed push into the sustainability space.

The firm’s decision to expand its sustainability-focused offering and slash existing exposure to undesired sectors will raise few eyebrows. BlackRock has previous form for sweeping changes to its business, and areas such as ESG represent one obvious growth source for a beleaguered active management industry. But it’s also a reminder that life could become more confusing for those running the likes of ESG portfolios: as more funds start to fit the bill, DFMs once more face a deluge of choices.

That said, it likely spells better news for investment managers looking to stand out from the crowd. As the number of eligible funds grows, portfolios with such remits should be less likely to crowd around the same smattering of holdings.

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