By Diane Earnshaw, research and consulting director at Square Mile
The most prominent trend seen in fund data this quarter – and one that shows no sign of abating – is the dominance of passive funds, which continue to lead net sales.
This trend has been in place for an extended period, driven by two main factors. Firstly is the underperformance of active funds as a genre. In the IA UK All Companies sector, for example, a fund needed to be in the top 25% of its peer group to outperform the FTSE All Share index over the past five years, and be in the top 15% to outperform over a three-year period.
This demonstrates how strongly the index has performed relative to the peer group of active funds. This trend is replicated across many other sectors where the average fund has struggled to outperform its respective benchmark index.
For advisers, this has undoubtedly made the justification of suggesting active funds to clients all the harder. Combined with the lower cost advantages of passive fund strategies and with the Consumer Duty requirements shining a further light on demonstrating value for money, the popularity of passive funds is not a trend we see changing imminently.
It is no surprise when we look at which asset management groups have been gathered the most assets in their passive products, led by the mighty BlackRock.
According to LSEG Lipper, bond funds saw inflows of £4.83bn in the first quarter with the bulk of this – some £4.57bn – going into passive bond strategies. Over the same period, equities as a whole saw outflows, while passive equity funds benefitted to the tune of £2.76bn inflows as the active to passive rotation continued.
A resurgence in sustainable funds
One interesting observation from the first quarter data is that sustainable funds have generally enjoyed net inflows, following a turbulent period for performance when the interest rate and growth cycle saw money flood out these types of funds.
While the hot money now appears to have gone, the ramifications are still being felt and we are increasingly hearing about groups closing their sustainable strategies where they have failed to be commercially viable.
In the last few weeks alone, Premier Miton has closed its European Sustainable Leaders fund, abrdn closed its Multi-Asset Climate Solutions fund, and even stewardship stalwarts FSSA has announced the likely closure of its Japan Focus fund.
This is not really a surprise given that fund groups are now grappling with how to implement the costly legal and regulatory ramifications of the new SDR labelling regime, weaker investor appetite and an oversupply of funds.
All that said, fund selectors need to offer sustainable fund strategies to those clients who express such preferences and so suitable funds and portfolio solutions have become an important option for advisers within their centralised investment propositions. The uptick in net flows is an interesting observation point.
The UK remains unpopular
Looking to regions, the UK market remains unloved and continues to see net retail sales. According to IA data, the IA UK All Companies sector remains the least popular for new investor flows over the last 10 years, a trend that has persisted into the first quarter of this year.
The reasons are well-versed – Brexit, companies de-listing, and a general investor preference for US and global equity strategies have all been headwinds for the home market. Consequently, the UK weight within large global indices has fallen from around 10% a decade ago to nearer 4% now, making the UK market significantly less liquid than larger global peers.
That said, the fund managers our UK analysts speak to remain mostly optimistic about the prospects for their funds and the UK stock market more generally.
Valuations are undoubtedly compelling for many UK companies relative to global counterparts and even more so further down the market-cap spectrum. In most cases these valuations are underpinned by attractive dividend prospects, which is reflective of strong operational performance.
The combination of these factors also makes UK companies attractive from an M&A perspective from private equity investors and increasingly so more recently, listed suitors.
Supported by this, and a falling inflation backdrop, the FTSE 100 hit a new all-time high in early May, though has pulled back more recently.
There is still a lot of catching up to do compared to other international markets, but a change in performance trend here is welcome relief for home market investors.
