Buy-list favourites ride out the reflation trade; A blindspot for US equity fund selection
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Relative winners
When absolute returns are positive, wealth managers generally feel pretty upbeat about life. Clients are focused on outcomes, and it’s much easier to discuss the finer points of relative returns when overall performance is in the black.
That said, many of those finer points are still preoccupying DFMs’ day-to-day thoughts. The market rotation seen over the past nine months has provided plenty of cause for rethink, even if there have been one or two blips in the reflation trade along the way.
Changes made to underlying fund selections have often been piecemeal rather than wholesale, and there’s reason for that. Look at the most popular funds in each of the main equity regions, and there’s no sign of calamity, even when viewed through the prism of relative rather than absolute performance.
In European, emerging market and North American equities, longstanding active favourites - BlackRock European Dynamic, RWC Emerging Markets, and Baillie Gifford American – are all top quartile since investors began looking to different parts of the market last November.
Indeed, when considering the single most popular fund in each equity region, it's only in UK equities where the top pick is fourth quartile over this timeframe.
Even here there are ample signs of life: switch the timeframe to 2021 performance alone, and Liontrust Special Situations is back in second quartile. In a similar fashion, Fundsmith Equity, the most popular global equity selection, is back in the top quartile year to date.
What this brief comparison highlights is that, for all the interest in market rotation, the best active funds’ short-term performance is separated by only very fine margins. There have been no big falls from grace, and even those whose styles are perceived to be ‘out of favour’ are continuing to deliver. That spells good news for the fund selectors who still back these offerings.
Supply shortage
Listeners to our latest podcast will have heard discussion of one particular oddity of ESG investing at the moment. When considering an ESG model portfolio, observers might instinctively think UK equity weightings would prove lower than they do in conventional portfolios – and vice versa for the US.
That’s because of the UK market’s well-known exposure to a variety of relatively unsustainable sectors, and on the flipside the US predilection for ESG-friendly tech companies.
As we discuss on the show, that's far from the case in reality. UK weightings are more or less the same, but the big difference is across the pond. In the vast majority of cases, dedicated US exposure in an ESG balanced portfolios is far below that seen in a traditional model.
There's one caveat here. ESG portfolios tend to hold more assets in global equity funds, most of which do have sizeable weightings to the US. But that speaks to the underlying issue: this is arguably a case of supply not meeting demand.
While there are more than enough providers of sustainable UK equity funds (despite the domestic market’s relative potential shortcomings on this front), there tend to be just two US equity funds that are favoured by sustainable portfolios: Brown Advisory US Sustainable Growth, and Legg Mason ClearBridge US Sustainable Leaders.
Until that changes, wealth portfolios are destined to hold relatively low amounts in the US – even if they’d prefer to do otherwise.
Sovereign swerve
Another quirk of ESG asset allocation to conclude: Tatton CIO Lothar Mentel has told FTAdviser that the firm’s ethical portfolios – which are admittedly distinct from its forthcoming ESG offering – are inherently riskier than its mainstream models.
There’s one good reason for this: the firm thinks governments are fundamentally “unethical”, and therefore Tatton doesn’t include government bonds as diversifiers. That stance is a hardline one relative to industry norms, but it’s true there are questions to be asked about how sovereign debt can fit into ESG models.
For now, many DFMs might be content to stick with investment grade credit, particularly if their house view on developed market sovereign debt doesn’t accord it the status of a ‘safe’ asset anyway.
