Are DFM’s taking enough active risk?

February saw a large national DFM firm announce they were making the ground-breaking decision to take an underweight position in UK equities for the first time since the 18th century. Ok, perhaps it wasn’t the 18th century but it might as well have been, it was actually the first time in 13 years. During those 13 years we have had the ‘credit crunch’ (or GFC – Global Financial Crisis as it now seems to have been rebranded), the European Sovereign and Banking crisis of 2011, the Ben Bernanke inspired ‘taper tantrum’ and more recently the as yet untitled sell off that started last summer on general global growth concerns.

Coming in to all of these sizeable sell offs equity market valuations were at best stretched and at worst completely unrealistic given the backdrop of uncertainty that was visible just around the corner. Given that crystal balls were not necessarily required to see the dangers that lay ahead and that DFMs are essentially paid to navigate the peaks and troughs of markets by their clients, it begs the question why has it taken so long to make an active call on asset allocation?

The company in question were not alone though, as another large rival also announced in January that they too were underweight UK equities, this time for the first time since 2010, in their case recycling in to US equities instead. However, perhaps the most surprising detail is that in both cases the allocation was reduced by a humungous……. 0.5%! Such a stance may make a marginal difference over a very long period of time (perhaps that’s why such moves are so few and far between) but if the market crashes a 0.5% underweight position isn’t really going to save a client much money.

Horses for courses perhaps, some DFMs may suggest they are long term investors, not market traders and that asset allocation calls are only made with a long term outlook. The industry as a whole though seems unwilling to take much in the way of benchmark risk for their portfolios and we would question therefore are they doing enough to earn their keep? We believe investors pay a DFM for more than just fund selection.

At Vertem we feel markets move harder and faster than ever and that by making meaningful asset allocation calls we can add significant value to portfolios by avoiding the draw downs of markets and reinvesting at lower levels. We also believe that clients pay us to add value wherever possible; to avoid the sell offs if we can, to be overweight the asset classes performing best. As a result, we can do and have underweight asset classes by up to 33% on a relative basis and overweight them by up to 20% on a relative basis (subject to remaining within a client’s risk boundaries). We have had fortunately timed significantly overweight positions to both Property and High Yield bonds during the last 6 years but never over weighted equities. For the latter asset class though we had significant underweights in 2011, early 2012 and from late 2014/early 2015 onwards, in each case reinvesting at significantly lower levels.

We’re not trying to be smug, although each occasion has indeed added value, as the most recent sell off provided some much needed compensation to portfolios where ironically we had been over exposed to risk in the fixed income space which had hurt performance. We are clearly taking a lot of reputational risk whenever we make these calls and perhaps that is what the industry at large is unwilling to do, however we continue to stick to our guns on our process as that is what we believe investors are paying us to do.

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