Welcome to Asset Allocator, FT Specialist's newsletter for wealth managers, fund selectors and DFMs.
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Yesterday we highlighted UK mid caps’ return to form. Today, more investors are starting to wake up to the runaway success of Japan’s Mothers index this year. But true to form, it’s the US where small and medium-sized share price returns really stand out at the moment.
Spurred on by investors’ sudden realisation that a ‘blue wave’ in November’s elections looks distinctly possible and might prove helpful for shares, the Russell 2000 is up 10 per cent over the past month. Mid-cap indices are up even more; that’s added to the healthy progress such shares had already made over the spring and summer.
This is pretty good news for DFMs, whose typical equity allocations give them more scope to try out different things in the US market. Many have been positioning for just this kind of event: small and mid-cap strategies have started to pop up in model portfolios more frequently this year, according to our fund selection database.
It’s not the familiar names who’ve proven most adept at capitalising on these moves, however. The likes of Legg Mason Royce US Smaller Companies has lagged the rally, as have Hermes US Smid Equity and Schroder Mid Cap. And it’s been a similar story for these portfolios over the medium-term, too.
There are isolated instances of old stalwarts continuing to do well, of which JPM US Small Cap is the prime example. But by and large it’s strategies that are less well known on these shores have been delivering the goods.
Granahan US Focused Growth is one such strategy, and it does now make an appearance on the odd UK buy-list as a result. Its concentrated small-cap portfolio looks like it’s not for the faint-hearted – but to its credit, the fund did slightly outperform peers during the slump in February and March, too. In this case, selectors who’ve ventured off the beaten track have reaped the rewards.
The core/satellite approach to US equity investing favoured by many UK selectors has helped diversify their holdings this year.
The big tech trades may be crowded, but those looking for alternative exposures have often sought to look elsewhere in the US market rather than rotate into the other regions that make up the global equity market. That’s given more US equity providers the chance to gain a foothold on UK buy-lists.
But while US equities remain uppermost in the minds of fund selectors across the world, that’s not quite the case for domestic buyers across the Atlantic. Morningstar noted this summer that US equity funds were, in fact, on track for their worst-ever year of outflows. The trend has continued into the autumn: a further $21bn was pulled in September, taking year-to-date redemptions to some $221bn. For comparison, no year since 2010 has seen much more than $60bn in net outflows.
Inevitably, this is in part a story about active manager woes: passive funds did see net inflows last month. But as a mature market, ETFs and trackers haven’t been wholly insulated from the negative sentiment, either.
So where is this money going? One answer appears to be bond funds. Taxable bond funds – ie excluding the likes of tax-exempt municipal bond funds - have racked up around $250bn in net inflows this year. Corporate bond funds, both investment grade and high-yield, have taken the bulk of that money. That’s a pattern that’s also been seen on these shores. Few UK-based fund selectors would have any truck with talk of a great rotation – yet something resembling that does appear to be taking place in the US.
As ESG considerations move further up the agenda, DFMs and stockbrokers used to direct investing face a tricky task marrying their intentions with their resources. Genuine engagement with companies requires much greater levels of commitment. Wealth managers may have grown considerably over the past decade, but there aren’t many who have that kind of capability in-house.
So yesterday’s news that Brewin Dolphin has tasked BMO with engagement responsibilities for £12bn of the former’s assets makes sense. There will be more of these mandates being awarded in the months and years ahead.
From a fund selection perspective, the main thing to watch for is that these relationships between provider and buyer don’t end up unduly affecting buy-list decisions. The lessons of the past few years, in which even vertical integration has struggled to have an impact on DFMs' investment processes, suggest this shouldn't be too much of a problem.