Yield hunt determines allocation shifts

22 June 2015
By Tiziano Giannotti

By Fiona Maciver

The summer months – a traditionally quieter period for investment markets – are rapidly approaching, but which sectors and asset managers are likely to stay on the radar? Aside from examining European fund buyers’ forthcoming allocation intentions, this month’s edition of Fund Radar also provides an update on what Distributor consider as the biggest drivers of industry change in coming years, with pricing, regulation, and interest rates dominating.

▪ European and Eurozone equities, and mixed assets, are the sectors most likely to benefit from increased fund buyer allocations in the coming months.

▪ Distributors now rank pricing as the main driver of industry change over the next three year

▪ Growth in selectors’ passive fund allocations has been relatively small over the last 12 months. View from the top

The macro-environment inevitably plays a weighty role in future asset allocation intentions. Since this topic was last covered in December 2014, economies and central banks around the world have steered different courses, creating both opportunities and threats for investors and rendering asset allocation decisions even more complex. Bond markets are now looking fragile, the prospect of a Greek debt default is on a knife-edge and the US Fed is shuffling closer to a hike in interest rates. But to what extent do such factors hold sway over fund buyers? Before considering what allocations they are ruminating for the near future, we first examine their thoughts on the key drivers of fund industry change over the next few years.

Agents of change

Fund Buyer Focus (FBF) reviews distributors’ perceptions of the drivers of change for the industry as part of its continuous programme of surveys. Interview respondents are asked the question: ‘What do you consider to be the most important drivers of change in the fund market over the next three years?’ Two of the top three drivers identified by distributors in the first quarter of 2014 shifted position by the end of the same period in 2015, with pricing/costs ousting regulation/ legislation as the number one driver of change. Changes in the economic environment both at home and abroad propelled interest rate/inflation concerns up three places into third spot.

This reordering of the greatest perceived challenges is not surprising, coming at a time when the tidal wave of new regulation is abating slightly and the ripple effect of implementation starts to reveal the future distribution landscape. The top two drivers are intrinsically linked, with regulation forcing a greater focus on fees. The fallout from the application of the retrocession bans in the UK and the Netherlands has helped to exert downward pressure on fees.

From a review of distributors’ qualitative comments on the subject, most expect pricing pressures to remain, sharpening the focus on active managers to deliver alpha returns at a reasonable cost. While numerous qualitative comments from distributors focus on the importance of price, there is a recognition that many current passive solutions have their limitations, giving rise to product development opportunities. The increasing prominence of cost considerations is clarified in feedback from a UK-based IFA/intermediary:

‘I think the most important driver of change in the fund industry over the next three years will be the downward pressure on fund charges. It sometimes seems as if every other personal-finance article is about ‘rip-off’ fund charges. Clients read these articles: I know that, because clients that we’ve had for decades and who have never raised this topic with us before are now coming to us and asking about it. Clients are becoming more aware of the whole area of value for money when it comes to fund products.’

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Active vs passive allocation

With pricing and costs deemed a key driver of change and record sales of some passive strategies registered over the last 12 months, what is happening to selectors’ overall asset allocation to active funds? Before looking at distributors’ thoughts on the merits of allocating to active or passive vehicles, it is important to highlight some distortions in the passive fund flows. The headline-grabbing numbers generated by these products are largely attributable to ETFs. For example, a spike in ETF sales in Q1 is a misleading indicator as the majority of ETF sales flows currently stem from institutional investors. For the retail market, it is more meaningful to take sales of traditional index trackers into account, which have been far more modest of late.

FBF interviews cover all third-party distribution channels. At the pan-European level, FBF data suggest an overall reduction to active funds of three percentage points over the 12-month period to 31 March 2015. The flipside is of course an increase in passive allocations, with all markets surveyed registering growth here. The biggest changes over the year, albeit modest, were in the German, Dutch and Swedish markets.

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The fund sectors du jour

We now turn to sector-specific allocation intentions. Our previous look at future asset allocation changes at the end of 2014 revealed mixed assets as the most popular category among fund selectors, while European equities were most likely to be on the receiving end of a reduction in business volumes. At the same time, fund selectors were broadly neutral on North American equities with an equal split of buyers expecting to increase or reduce allocations. Emerging markets were back in vogue, while some flavours of bonds remained in favour, too. What a difference six months makes! The latest data from FBF, for the first quarter of this year, suggests that European equities, Eurozone equities, and mixed assets are the most likely recipients of any positive short-term changes to asset allocation. The ECB’s quantitative easing policy sent European equity markets soaring during the first few months of the year, along with demand for Europe-focused funds, with the returns much needed by investors starved of yield in deposits and traditional fixed income products. Selectors have been eyeing up other higher-yield options too, with alternatives appearing high on the list of potential allocation increases.

Contrary to the European story, North American equities have moved from net neutral sentiment in Q3 2014 to being one of the sectors most likely to suffer a reduction in allocations, being used in part to fund a rotation into Europe. Negativity towards the sector has already filtered through to sharp net redemptions in March and April’s sales data. As inflationary pressures build and the prospects for higher US interest rates edge closer, investors are turning their attention to other areas. The ongoing popularity of mixed assets has been particularly strong among retail investors. As predicted in December, the sector has continued to benefit from increased distributor allocations, which have translated into mouth-watering sales figures for the sector. During the first quarter of 2015 alone, mixed asset fund sales tallied up to €63bn – almost double the amount during the same period in 2014. This not only reflects the willingness of more retail investors to place money in funds but also the return of the retail banks to fund distribution, with more profitable packaged solutions being sold to captive clients.

As for fixed income funds, the ideal combination of allocations is difficult to determine in the current environment. Government bonds, particularly those denominated in US Dollars, ranked as the first quarter’s sectors most likely to see immediate reductions. At the other end of the spectrum, the demand for corporate, high yield and emerging market bond funds looked more favourable at the time of writing.

Naturally, there are some differences between the demands of wholesale and retail distributors. Notably, wholesale fund buyers’ equity appetite currently extends beyond European equities to regions further afield, including the emerging markets and Japan. Each European fund market is characterised by its own nuances and the preferences for allocation increases vary at both the market and channel levels. While the survey sample size, at a country level, is relatively small, responses highlight some interesting differences in local markets. For example, alternatives are near the top at present for Belgian, Dutch and Swedish fund selectors, while European equities are more likely to be catching the attention of French and German buyers. Of course, the macro-environment and investor sentiment are fickle things, and subject to change at any time. The sectors that have been highlighted here are indicative of the latest tastes but should not be read as guarantees of future allocations!

Preferred suppliers

Asset allocation shifts invariably produce winners and losers. Redemptions have recently been a feature in some of the bond sectors but other sectors are strengthening so who are the potential beneficiaries of new business for the sectors or asset classes that are likely to see expanded allocations? For European equities, widespread brand penetration has proven valuable to Europe’s larger houses, which currently dominate the preferred suppliers list here. Of the groups mentioned, the most successful for net sales flows into European equities during the first quarter were Invesco, BlackRock and Henderson1.

Given the notable shifts in favoured suppliers of mixed funds, we have highlighted in red the managers that have appeared in respective markets’ top five when compared to our previous review, which covered data up to Q3 2014. For the overall sector ranking, Invesco dropped out of the top five while Ethenea moved up into fifth position. At a local market level, there were a number of changes – particularly in the highly competitive British market, with four new entrants among the top five. 1 As per Broadridge FundFile data.

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The allocation outlook

In both Europe and beyond, the short-term outlook for investors is, at best, unsettled, making conditions increasingly difficult for portfolio construction. The looming threat of a Grexit is the most obvious cloud on the horizon. More seasoned investors are better equipped to weather the storm. For the less experienced retail investors, the major challenge will be for product providers and advisers alike to convince them of the long-term benefits of investing in funds. Mixed asset funds are set to continue dominating sales in 2015, but their success is dependent on product providers helping retail investors to hold their nerve in choppy waters. Providers of mixed asset funds must therefore clearly demonstrate the true value of their products. Meanwhile, bond sales are likely to be close behind, with equity sales lagging some way off in third place.