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Wealth portfolios struggle to keep pace with ESG equivalents; One more reason to end home bias

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Sustainable growth

Lest there were any doubt, the events of 2020 have made it clear to all that ESG is no fad. Wealth managers’ own portfolios are increasingly reflecting this reality – and so too are their relative returns.

When we last checked in on the performance of wealth firms’ ESG model portfolios versus their traditional counterparts, it was clear that the new breed had displayed more resilience during a rocky first quarter.

Five months later, all allocators acknowledge that markets’ subsequent rebound has been just as kind to strategies prioritising environmental, social, and governance factors.

That’s again reflected in DFMs’ own offerings. ESG balanced models have outperformed their standard equivalents by 2.5 percentage points since March – having done exactly the same in the first three months of the year.

And there’s not much evidence of the trend slowing down: while the performance gap narrowed in the third quarter, the proportion of DFM ESG portfolios outstripping regular balanced offerings was as high as in the first quarter.

Performance is only part of the equation, and there’s no guarantee that such strategies will continue to outperform. But for now, it does make ESG conversations that bit easier to have with clients.

The immediate upshot of what’s proving another watershed year for the theme is that more wealth firms than ever before are now adding ESG strategies to their conventional strategies, too. And that points to the biggest change of all: it may become increasingly difficult to tell the difference between an ESG portfolio and a “conventional” equivalent.

Leaving home

Another key theme of 2020 – though this one may ultimately prove more transitory – has been the shift away from UK assets. We’ve repeatedly charted how UK equities have continued to fall from favour this year, among both DFMs and fund firms.

There’s a considerable home bias to overcome on this front, so the standard DFM allocation remains pretty hefty relative to other equity regions. But it’s clear that a rotation which first began a few years back has continued in earnest in recent months.

UK indices’ relative underperformance also has knock-on effects elsewhere in the wealth management world. We’ve previously commented on the eyebrow-raising returns of riskier Pimfa indices which prioritise global rather than domestic assets. And rebalancings elsewhere are also starting to reduce UK weightings.

Distribution Technology, for example, recently changed its asset allocations in a way that reflects DFMs’ own thinking of late: dialling down UK shares in favour of US equities. That could have a further impact, at the margin, on how risk-rated portfolios view their equity positions. The benchmark risk of cutting UK positions just got a little easier to stomach.

What’s more, the Distribution Technology changes also involved a reduction in UK corporate bond positions, with global credit the beneficiary. That’s a less common sight among UK fund selectors – but as allocations continue to go global, it’d be little surprise if bond positions started to follow their equity cousins in the coming months.

Doing the job

If last week’s risk-asset blip was one of those from which investors couldn’t really draw any firm conclusions, yesterday’s market moves across the Atlantic were a little more familiar.

US shares suffered their worst day in a month, the S&P closing down almost 2 per cent having been almost 3 per cent lower at one point. Worries over a lack of fiscal stimulus and a big increase in US coronavirus case numbers were the two main culprits for the drop.

The good news for allocators, however, is that treasuries rallied strongly in response. US government debt proved again that it can and does still have an inverse relationship to risk assets. This wasn’t the toughest stress test, but as a basic indicator it may have given some reassurance to wealth firms and their portfolios.

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