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DFMs show little appetite for UK hidden gems; Selectors move off the beaten track for passive plays

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One off

DFMs’ buy-lists have undergone a minor overhaul this year as allocators prep portfolios for unusual times. But does a rethink of priorities mean buyers are diverging in their tastes?

As we discussed yesterday, that’s seemingly the case in the US. As it stands, more than two in five US equity strategies in our fund selection database are held by just a single DFM. The chart below shows how that compares with other parts of the equity market.

The chart doesn’t rule out buy-list concentration in a given region. It’s perfectly possible for an asset class to include a long tail of idiosyncratic picks and a handful of strategies favoured by multiple DFMs. What it does show is how willing allocators are to spread their wings.

In theory, this is easier to do in regions which feature more heavily in allocations. Most wealth portfolios will have much more in the US than in the likes of Japan or Asia – and hold more US equity funds as a result.

But it doesn’t always pan out that way. In the UK, the tendency to rely on a small group of core holdings isn’t accompanied by innovative selections elsewhere in the asset class. Domestic allocations remain a material part of most portfolios, yet there are relatively few funds that appear on just one buy-list. The obvious conclusion is that there are few hidden gems to be found in the UK market.

Selectors find it easier to discover overseas funds that aren’t on peers’ radars, or that they think have been unfairly overlooked. Japan is one such case. Compared with other equity regions, there are relatively few viable Japanese picks out there for fund buyers. Nonetheless, there’s still plenty of idiosyncratic options on show in buy-lists. The puzzle of how best to access the Japanese market has got no easier to solve in recent years.

Off the beaten track

The chart above only takes into account active fund selections. But that’s not to say there’s no divergence when it comes to passives. Many wealth firms are now looking beyond the staple index trackers in favour of other options. The US is again a case in point: with index returns being driven by the Faangs, buyers are honing their passive exposure to either capitalise on this trend or downplay its impact.

But this hasn’t translated into a rise in the use of smart beta products, at least in the traditional sense. Strategies targeting particular investment styles remain low down the agenda for discretionaries; few feel confident enough to target either growth or value at the moment, given respective performances over recent months. Instead, buyers are using passives to turn to specific sectors – like healthcare – or looking lower down the cap spectrum.

In other regions, meanwhile, growing competition among providers is giving DFMs more options. In the most liquid asset classes, the big players tend to exert their muscle to drive down costs. In other areas, however, smaller providers have been able to undercut the established names.

And when it comes to passives, every basis point counts. That’s particularly the case now that a wide range of fund firms can be relied on to track indices relatively well. As an FCA release last week implied, egregious tracking errors have declined notably over the past few years – or else poor players have simply been pushed out of the market.

Worth investigating

A separate FCA release published this morning could have a more direct impact on wealth managers. In a call for input on the workings of the consumer investment market, the regulator has sought to stem the tide of bad practices that have ultimately washed ashore at the Financial Services Compensation Scheme in recent years.

One particular point of interest is its look at the current exemption afforded to high net worth and ‘sophisticated’ investors when it comes to financial promotions. As it stands, promoters – regulated or otherwise – are able to target investors deemed as such.

Understandably, if belatedly, the watchdog is seeking to tighten what defines a HNW or sophisticated person. Clamping down on the targeting of these groups can only be of benefit to wealth managers – both from the point of view of industry reputation, and because such investors would be more likely to seek out regulated services as a result.

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