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Then vs now: DFMs at the point of maximum panic; Keeping an eye on AUM slumps

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Then and now

Research from Arc published this morning shows that DFMs have what it takes to outperform – albeit only at the margin.

The firm has examined upside and downside capture ratios since 2009 for its universe of steady growth portfolios. It found that 14 of the 28 discretionaries with long enough track records managed to deliver “material downside protection” to investors during market drawdowns.

Suggesting that private clients “do not value gains and losses equally”, Arc sees this as a good result. But while performance metrics can be endlessly debated, allocators themselves will be more interested in exactly how they achieve that downside protection. And the evidence suggests approaches haven’t changed too much since the last slide.

As it stands, the end of Q1 2020 looks like something of a market bottom – just as the last major drawdown, in Q4 2018, also reached its nadir at the end of that quarter.

Discretionaries’ positioning at the moment of maximum worry wasn’t quite the same as last time. This time around, as we indicated last week, equities exposure is lower. At the end of 2018, the average equity allocation was 56.5 per cent rather than 53 per cent.  That’s been offset by higher cash and bond weightings – the former has risen from 6.1 per cent to more than 8 per cent in the typical Balanced portfolio.

Alternatives have also given way somewhat: the average allocation here has dropped from 16 per cent to 14.5 per cent now. But considering the end of 2018 was the point when DFMs really started to fall out of love with absolute return strategies, many would have expected an even bigger drop. It suggests wealth firms’ disillusionment with alts isn’t as unequivocal as some may think.

Poor company

But there’s no denying certain absolute return funds have fallen from favour in recent times. BMO Global Equity Market Neutral, for example, is now being wound down after its performance slump saw assets hurry for the exit.

In the last six months alone, AUM has fallen from £363m to just £4m, according to FE. In this case, returns are clearly to blame. But it’s far from the only strategy in the UK fund universe to see assets suddenly evaporate – and performance isn’t always the culprit.

The rise of the big fund buyer means more funds are nowadays at risk of seeing their AUM drop like a stone. If one holder accounts for a sizeable proportion of assets, their decision to redeem can have a material impact on the future of the strategy itself.

DFMs have long been conscious of this kind of co-investor risk – not least because they themselves are often the big buyers in question. And it’s one more reason why many selectors effectively rule out holding any fund with less than £100m in assets.

It’s not just small funds that are materially affected by big investors’ decisions. Larger strategies, like Artemis Income and JOHCM UK Equity Income, have also seen sizeable amounts hived off from their main portfolios over the past year. In these instances, the rise of segregated mandates is to blame, as large clients prefer to have their money managed in a separate structure.

The viability of portfolios like these isn’t called into question by such shifts. At the same time, the changes emphasise that DFMs should be keeping as close an eye as possible on the behaviour of their fellow fund holders.  

Hunkering down

A related point comes via the news that Hargreaves Lansdown is to cut down its Wealth 50 buy list. Action on this front has long looked inevitable given the Woodford saga. More notably, the Sunday Times also reports that Hargreaves is expected to reduce the stakes its multi-manager range holds in certain funds as part of the overhaul.

Given these stakes amount to more than 20 per cent of certain portfolios, those reductions could well produce more AUM drops of the kind discussed above.

DFMs’ own buy list positions are unlikely to ever attract as much scrutiny as Hargreaves’. But some wealth managers have also been scrutinising what constitutes an oversized position – particularly in light of the emphasis on liquidity prompted by Mr Woodford’s downfall. In some cases, that’s accelerated the shift to segregated mandates. In others, it means taking a more prudent approach to position sizing for the foreseeable future.  

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