Welcome to Asset Allocator, FT Specialist's newsletter for wealth managers, fund selectors and DFMs.

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Passive persistence

Last week, we asked whether wealth managers would be dialling down their passive exposures in the near future. Some might suspect that process has already begun, given the perceived need to take more refined positions in both equity and bond markets. But the evidence on this front is decidedly mixed.

To test the theory, we’ve looked at a sample of discretionary balanced portfolios – those that typically invest in both active and passive funds – to see how views have shifted over the past 12 months.

Starting at the end of March 2020, when risk assets were at their lows and panic was at its height, we examined how passive positions changed. The short answer is: not much at all.

As of the start of this month, passive weightings stand at 17.7 per cent of the average portfolio, compared with 18.2 per cent at the end of both Q1 and Q3 last year.

But this drop has stemmed from just one part of the market. As the chart below shows, there’s been a gradual move away from passive bond options over the past year, with the typical weighting dropping from 5.3 per cent to 4 per cent.

Given the ruptures seen in Q1 2021 in particular, that’s not so shocking. Nor is the continued demand for 'other' passives, predominately precious metals ETFs. What’s more surprising is the resilience of equity market trackers and ETFs.

Passive equity exposure moved higher in the six months to last September, perhaps as DFMs sought an easy way to ride the rally. And there's no sign of it going into reverse just yet.

This may in part be due to the range of passive options available – smart beta offers the ability to access specific investment styles, and global trackers have proven a cautious solution for some of those trying to (slightly) reduce their exposure to the US. And we should also note that passives still make up just a fifth of DFMs’ overall equity exposures: most blended portfolios already focus on active funds. Be that as it may, there’s no sign of a shift away just yet.

A minor reassessment

For those hunting for reasons to be cautious, the US market is still throwing up a few relevant signals. Latest fund flow data from Bank of America indicates its hedge fund clients were net sellers of US equities for the fourth week in a row last week, with institutional clients following suit for the second successive week.

That meant it was only retail investors still buying – and even they did so at the weakest rate since the middle of February. Value ETFs, meanwhile, saw their first week of selling for three months.

All this said, these trends look like they’re due to profit taking more than anything else. Only four of the 11 sectors tracked by the bank saw net selling – and these were cyclical areas like financials and consumer discretionary.

Conversely, there were renewed inflows for staples shares, and the best inflows for healthcare since early January. That'll be of reassurance for those UK-based wealth managers who are either sticking with their existing US positions, or adopting a barbell or core/satellite approach.

Having been burned before, there are very few DFMs who have shifted to a wholesale value approach. And with volatility gauges hitting their lowest levels since the pandemic, there’s little sense of alarm on the part of any group of investors. Some fund managers are again confident enough to state it’s “hard to construct a bear story in any way” for the weeks and months ahead.

Small hope

New hope has arrived for those who still bemoan the dearth of analyst coverage of small-cap companies in the wake of Mifid II. An FCA consultation paper released today has suggested smaller-company research be exempt from unbundling rules.

In itself, this isn’t a sign of the UK regulator taking advantage of Brexit rules to reshape Mifid for a domestic audience. Instead it’s following in the EU’s footsteps – the latter made the same proposal last summer.

What is different is the size of those companies. The EU said the rules could apply to firms with a market cap of less than Є1bn. The FCA has opted for an upper limit of £200m. As has happened in the past, the UK watchdog is taking a slightly more stringent approach than its counterparts on the continent.