Six months ago we predicted that UK-domiciled funds would experience a mix of sun and cloud. Since that forecast, it is safe to say that there has been a lot more rain than predicted. The story, however, has not been entirely gloomy, and our forecast, generated using ISS Market Intelligence’s Flowspring analytical tool, has had its share of hits in addition to essentially one significant miss.
Figure 1: UK Domiciled Fund Forecast and Result
Key takeaways from the past six months
Mixed funds continue to lead the way, and why wouldn’t they?
In our previous forecast we commented that a gloomy economic picture left investors few places to hide, a situation that largely played out. Indeed, asset values across the board have taken a hit in the past year. Based on this assumption, forecasting that investors would opt for diversified solutions, hoping to find a patch of green grass, or stay on the sidelines, made sense. It therefore came as no surprise to see that mixed funds were the only fund type to collect positive flows of any note.
The mixed fund story, however, is much bigger than short-term investor sentiment. Mixed funds have posted positive flows in 110 of the past 120 months and look set to continue to benefit from a trend with far-reaching retail distribution implications; the outsourcing of the investment proposition by advisers. Outsourcing of the investment proposition continues to be propelled by a desire to streamline the investment process, increased compliance requirements related to know your product and the reorientation of advice value propositions from investment selection to holistic planning. As long as this remains the case, mixed funds, as the original flag-bearers for the delegation of the asset allocation decisions to asset managers, look well positioned for success.
The outsourcing of the investment proposition involves the relocating of fund and security selection away from the adviser to an investment specialist. (Incidentally, this is why quarter of a century ago we coined the term “preassembled advice solutions” to capture the raison d’etre of Mixed funds and all types of diversified fund portfolio solutions.) It can be done either through an in-house solution, especially with larger advice firms, or externally, through a fund manager or discretionary fund manager (DFM) by using either a fund of fund (FoF) solution (see article 1 UK FoFs) or model portfolio services (listen to our ISS MI Talks podcast). With both FoFs and portfolio services mainly investing through other investment funds, continued growth in outsourcing will have significant impacts on UK domiciled fund flows.
If FoFs become the outsource vehicle of choice, mixed funds will naturally benefit as the host of most of these funds. On the other hand, if MPS, including bespoke portfolio services, see higher growth, mixed funds may only see limited benefit. The extent to which mixed funds will benefit in this scenario, will be dependent on whether most large MPS providers move to using FoF building blocks to implement their models. For UK-domiciled stand-alone funds, the impact of this movement will depend on the domicile of the underlying funds used. Will FoF and MPS providers stick to the UK or look to Ireland and Luxembourg? For insight into the use of European funds in FoF solutions, check out: (Eur(ope) Welcome article)
Equity has lost its mojo
The fund forecast missed by £26.2 billion over the past six months; £25.4 billion of that figure was due to the equity fund forecast. Where did we go so wrong on equity? It must be performance, right? Not so fast.
On an asset-weighted basis, all other fund types included in this analysis performed worse on a six-month basis. It also does not explain why over the past 120 months, whether equity funds had positive or negative monthly net flows was essentially a coin flip. In only 65 months were flows positive. This period includes one of the longest running bull markets.
Indeed, if we dig deeper into our data banks, we can only come to the conclusion that there may yet be an unidentified structural force at work and that investors have turned their back on the UK and Europe. If we look at our biggest misses and the hardest-hit equity categories, we see that UK and European funds faced significant redemption pressures in the past six months. The picture over the past 10 years is not exactly rosier.
Figure 2: UK Domiciled Equity Strategy Forecast and Result
UK and European equity funds have seen nearly £80 billion in total outflows over the past 10 year – a period that includes Brexit, a war and a mini-budget crisis most recently in the UK. Over the same period, global, US and sector equity funds have gained a similar amount. There likely has been some repositioning within equity then. Equity funds as whole, however, have essentially seen zero net flows in 10 years. Mixed funds meanwhile, have seen over £100 billion in net flows in that period, and bond funds are also well into the black for flows. The question then remains, why not equity? And can equity expect much of a rebound even if the economic clouds dissipate? A question we will ponder in a future article. To answer this question, consideration will be given to demographic trends, where FoFs are investing their money, investor portfolio positioning, and if institutional and retail share classes have had the same fate.
‘If you have to forecast, forecast often’ – Edgar Fiedler
With so much having changed over the past six months, our next article will provide an update on our forecast and will attempt to answer the question: Will the money that exited return?
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Commentary by ISS Market Intelligence
By: Benjamin Reed-Hurwitz, Vice President, EMEA Research Leader, ISS Market Intelligence
