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Damage assessment

Relative returns, as a concept, can look pretty small fry after a quarter in which major indices dropped by double-digit amounts. Wealth managers themselves know more than anyone that it’s outcomes that matter most to their investors.

At the same time, the nature of the external shock suffered in Q1 gives DFMs more wiggle room than usual when discussing performance with clients.

From a risk-rating perspective, we noted last month that February portfolio performance was largely consistent with expectations. When it comes to overall performance, underlying fund choice is just as crucial – and our analysis today suggests DFMs are still tending to make the right choices, even after a quarter in which everything changed.

The chart below shows how many of the ten most popular DFM active fund selections in a given sector outperformed in Q1 – charted against the proportion of the overall sector that did so.

As the bars show, in most cases discretionaries’ favourites did better than the wider active fund universe. That was particularly the case in the US, where active funds’ natural tendency to favour tech continued to stand them in good stead at the start of the year. The same can be said in Europe, albeit for different reasons – a longstanding aversion to financials was a major driver of relative returns for many.

In the UK, fewer top picks stood out – and funds in general struggled to match up to the FTSE All-Share, in part due to their mid-cap bias. But the three top picks that did flourish, relatively speaking, were those favoured most heavily by DFMs.

It was a different story in the emerging markets. The typical fund struggled to post respectable returns, and discretionaries’ choices were no better. And in Japan, where equity markets fared better than in most over the course of Q1, fund selectors were behind the curve. Just one pick – Lindsell Train Japanese Equity – beat the Topix over the period. Some of the more aggressive favourites, like Legg Mason’s offering, did make a valiant effort at limiting losses. But the majority of longstanding favourites faced a tougher time of it.

Fast and loose

Those who thought central banks were out of ammo have had a lot of counterpoints to consider in the past few weeks. The Federal Reserve’s commitment to backstopping ever-larger sections of the US economy has helped underpin both equity and bond markets as corporate cashflows dry up, and the European Central Bank hasn’t been shy to get involved, either.

Initial moves aimed at expanding QE programmes and easing market liquidity have been complemented with, in the Fed’s case, a programme aimed at helping the global dollar shortage.

And while those schemes grabbed the big headlines, an array of new measures continue to filter out on an almost daily basis.

On Monday, the Fed said it would purchase emergency loans made by banks to shore up small businesses – its latest bid to ensure new lending initiatives have functioning secondary markets. Yesterday, the ECB eased its collateral requirements when providing credit to banks.

But in Europe, although these programmes help shore up market confidence and provide a degree of stability to the economy, there’s a third demand that they’re failing to meet. The relative opacity of such initiatives, coupled with high-profile failures to co-ordinate at a government level, mean faith in the eurozone project in countries like Italy is getting shakier.

Blame can’t really be laid at central banks’ door – ECB president Christine Lagarde has followed her predecessor Mario Draghi in calling for more action from governments. But initiatives yet to get off the ground, such as ‘coronabonds’, are breaking through to the public consciousness in a way that successful measures like the ECB’s PEPP programme are not. That may be storing up problems down the line for both Europeans and those who invest there.

Discount discontent

There are obvious reasons to avoid emerging market shares at the moment - even if some economies are proving more adept at withstanding the spread of Covid-19 than their developed market peers.

But the extent to which investors fled EMs in the first quarter was dramatic nonetheless. Redemptions dwarfed those seen during the financial crisis. That’s despite there arguably being little ‘hot money’ left in the sector this time around.

So it’s not a huge surprise that the relative valuation difference between US and EM equities now stands at a record high, according to the Institute of International Finance. Even this, however, isn’t enough to bring the bulls in. JPMAM’s EM veteran Richard Titherington puts the difference down to US overvaluation rather than an array of attractive emerging opportunities. That downbeat assessment of developing economies is one shared by most fund selectors at the moment.