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Asset Allocator

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Where and when DFMs turn to trackers and ETFs; Alts allocations approach the event horizon

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Tracking the trackers

Wealth portfolios have been rejigged over the spring and summer in response to 2020’s new normal. But most of the talk on this front has been about tech and ESG - less attention has been paid to the old saw of active versus passive.

That’s a pretty tired debate nowadays, but it’s worth investigating just how far the prevailing trend of the past decade – the growing interest in passive products – has gone. The chart below shows the current state of affairs for DFMs’ equity fund picks.

The clear standout, as you’d expect, is the US. As we noted last Monday, passives now dominate US equity fund selection more than ever – despite the growing number of idiosyncratic active funds used as satellite holdings in the asset class. A typical DFM portfolio is now more likely to go passive than active when it comes to US equities.

Elsewhere, there’s a remarkable consistency in most regions: on average, one in five fund picks is a tracker or an ETF. Nor have these figures changed much over the past 12-18 months: there’s been little sign of a radical reconsideration of how portfolios are structured.

That said, there are one or two subtle differences between regions that are masked by the outsized US bar.

European equities are a case in point. DFMs are almost twice as likely to go passive in Europe as they are in Japan - despite the fact the typical moderate portfolio holds roughly the same weighting in the former as in the latter. And the gap between the two has widened this year: those discretionaries who’ve sold down European equity positions have been more likely to get rid of active exposure than passive holdings. That's the most notable active vs passive change to have emerged from the 2020 reshuffle.

Drive for change

Alternatives are one part of the fund selection world that remain pretty well insulated from the passive rise. But this doesn’t make fund research any easier: quite the opposite. Wealth managers continue to search far and wide for strategies that can do something a little different - with mixed results.

One burgeoning area of interest is a hitherto under-owned part of the hedge fund world. Historically, event-driven strategies haven’t tended to feature highly in DFM portfolios. But over the past 12 months, several buyers have added these options to their buy-lists. They’re not alone on this front: alongside convertible arbitrage offerings, event-driven funds are the only segment of the US hedge fund world to see net inflows year to date, according to eVestment.

The thinking behind these moves is relatively simple. Such strategies are something of a beta play, albeit not quite so aggressive as the likes of long/short options. Performance during the spring sell-off wasn’t truly terrible, either. And the touted qualities of event-driven funds – targeting company-specific events – imply a back-to-basics approach of fundamental investing, all too rare in a world where the macro dominates conversations.

Some have also tried to pin the recent renaissance on ESG, the idea being that holding just a handful of companies makes it easier to avoid nasty surprises. That’s a bit of a stretch – not all catalysts for change are ESG-based, even now – but it’s true that event-driven funds’ practice of actively engaging with company management would fall into this category.

Negative charge

The Bank of England’s dance around negative interest rates continued last week, with the news that it’s to examine how sub-zero rates might work in practice. Cue plenty more rune-reading from analysts as to whether this is a deliberate indication that such changes are on the way.

There’s already been plenty of fuel for the fire on this front, governor Andrew Bailey having U-turned on his initial disavowal of negative rates just one week later in May.

The consensus on the latest move is that while the BoE may ultimately go down this path, it won’t do so just yet. A fourth-quarter consultation is deemed in some quarters as indicating that any implementation is at least six months away. An alternative view is that a no-deal Brexit is the only real catalyst for change on this front: whatever the results of the BoE’s internal analysis, it’s this outcome alone that would make a move below zero probable.

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