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The booming fund trend still shunned by selectors; Flows data masks early warning signs

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Off trend

Thematic funds, both active and passive, are on the march - that’s the conclusion of a new paper by Morningstar. But both the findings and DFMs’ own inclinations raise questions about the wisdom of these choices.

Globally, there were more than 900 equity funds focusing on a specific theme in existence at the end of 2019 - with over 300 having been launched in the past two years. Europe accounts for a third of these funds and half of their assets, and the space has enjoyed three years’ worth of consecutive quarterly inflows.

Yet the continent’s cohort of specialist funds face the same challenges as those elsewhere - their long-term viability is in doubt. Of funds launched prior to 2010, just 40 per cent remain. And just a third of this group have outperformed the MSCI World index. 

Wealth managers’ own interest in thematic strategies remains pretty muted, our own figures suggest. That’s the case even if Morningstar’s stringent classification rules are broadened out. The ratings agency has distinguished thematic offerings from sector strategies, meaning the likes of financials funds don’t count. Even tech funds - by far the most popular thematic vehicle - are only included if they explicitly target one or more tech themes.

Including both financial and tech names does little to boost discretionaries’ appetite for thematics. Remove a handful of Polar Capital funds from the equation, and the number of thematic or sector funds that are used in more than one DFM’s model portfolio ranges stands at just three.

Nor is there a particularly wide range of funds being used - either active or passive. As that implies, growth in this segment of the market has been pretty much non-existent. Professional fund selectors, on the whole, are far from convinced by this particular boom.

Stampede

Conventional sectors and asset classes have enjoyed a resurgence of interest so far this year - or they did until February brought a new reason for market nervousness. Figures from the Investment Association show investors put a net £4.2bn into retail funds in January, the highest amount for two years. 

And the enthusiasm was pretty broad-based. UK equities unsurprisingly failed to match the pent-up demand seen in December, but growth-focused domestic funds continued to see net inflows. Europe ex-UK was the only anomaly when it came to equity regions; all other geographies saw money coming in, too.

The risk-on theme was also apparent in the bond market, where both the high-yield and EMD sectors enjoyed their best month for more than a year.

Similarly, wealth managers would’ve felt a little better themselves. Net retail sales via DFMs stood at £428m, the highest level since last June and only the third positive month since that point. 

Yet, as ever, there were signs of caution. Sales into pension wrappers - which, in the pension freedoms era, have long since overtaken Isas as the driver of retail sales growth - saw their first net redemptions since the introduction of the reforms in 2016. 

What’s more, money market funds took in £626m on the month - the highest level for at least four years. Anomalous moves like this are often the result of one or two big buyers as opposed to a shift en masse. Either way, it suggests some selectors - and perhaps retail investors, too - had significant worries about valuations or the risk-on attitudes of their peers.

A big blip

Last month’s deals between Franklin Templeton and Legg Mason, and Jupiter and Merian, looked to be very much par for the course in a consolidating sector. But investment bank Piper Sandler has shown that M&A activity among asset managers dropped off sharply last year - at least in terms of overall value.

The total worth of such deals fell by half to $13.5bn, even though the number of transactions rose. As that suggests, big deals were few and far between, with the bulk of the activity taking place lower down the size chain. 

Banner deals like Aberdeen and Standard Life, Henderson and Janus Capital and now Franklin and Legg are often seen as representative of trends across the industry as a whole. But there’s a possibility that these mega-mergers will remain exceptions to the norm. It’s far from certain that the latest big merger will prompt a flurry of similar deals among the industry’s very largest players.

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