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Thematic funds struggle to pass muster; The retail vs institutional fund flow shift

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Thorny themes

The rise of thematic investing has been a feature of fund selection over the past 12 months, but taking targeted exposures isn’t always a shortcut to success.

In 2021, fund selectors are increasingly looking at specialist strategies to diversify their equity positions at a time of elevated valuations. Last year, the trend had more to do with an eagerness to tap into the tech rally.

Then there’s ESG. The focus here remains on addressing clients’ specific needs with specific funds, and this applies to advisers as well as DFMs.

A recent survey from NextWealth notes that most advisers believe ESG criteria will apply across all portfolios “in the fullness of time”. For now, however, they are favouring individually branded strategies.

Many of these are simply regional funds with an ESG overlay – but the shift to sustainable investing has also opened the door to more specific investment focuses.

Add to this the rise of smart beta, and it’s no surprise that the number of customised benchmarks has ballooned alongside the rise of thematic investing. Both passive and active strategies need to measure their performance somehow.

Yet as the Lex column notes today, there’s often a trade off here. Less than a third of thematic funds have outperformed the MSCI All Country World Index on a five-year view. That suggests fund selectors – whether they have an ESG focus or otherwise – need to be on their guard.

Behind the numbers

April fund flow figures from Calastone add another dimension to yesterday’s European equity discussion. The region remained out of favour last month, seeing negligible inflows in what Calastone says was another record month for equity fund sales, but there is the hint that buying has restarted in some quarters.

The firm notes that turnover in European equity funds was the second highest on record, indicating – given the lack of inflows overall - “widely diverging sentiment among investors”.

There are signs of this interest in Morningstar’s own monthly flows data, too. A European fund made a rare appearance in the 10 best sellers last month, Invesco European Equity notching up its best month for inflows in over a decade.

But Europe remains a very small part of the overall fund flow picture. The Morningstar data also highlights a reversal in bond fund sentiment: UK gilt strategies collectively began attracting money again, while outflows from corporate bond strategies continued to accelerate.

As is increasingly the case with fund flow data, such figures may be distorted by one or two big buyers shifting their mix of holdings. That’s a particular risk when it comes to tracker allocations.

Yet these are the exceptions rather than the rule. It’s still retail sales – be they advised or otherwise - that are driving overall fund flows. That’s been a common theme since the pandemic began: you have to go back to Q1 2020 to find the last time that institutional flow activity was of a similar scale to retail turnover.

Since then, there have been five consecutive quarters of heavy retail buying, while institutional activity has been minimal. The latter may reflect high turnover masking diverging sentiment – as per the European equity trend described above – or it may be that many institutional buyers are increasingly opting to just sit on their hands.

Safe house

Corporate bond returns have been knocked this year by the pressure being placed on sovereign bond yields. But spreads for some companies are tighter than ever before.

Amazon sold $18.5bn of debt this Monday, and the FT reports that the company’s $1bn two-year bond paid just 0.1 percentage points more than the yield on equivalent US Treasuries. Its three- and 20-year maturities also matched or set new spread records, though the 10-year crown stays with Procter and Gamble, which sold debt at 0.47 per cent above Treasuries last year.

The story this tells about US markets isn’t uniformly positive, however – while the sight of companies being deemed ultra-safe stores of value isn’t particularly new – and nor is the huge appetite for such assets – there is the sense that the pool of these corporates is shrinking rather than increasing.

Consider the increase in the ranks of BBB-rated companies in recent years. That’s not to say those lower-rated investment grade credits are bad companies. But there’s certainly been a reduction in the number of firms that are perceived to be truly “high quality”.

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