Asset Management

GUEST ARTICLE: The Value Of DFMs As Markets Reach New Highs

Craig Melling 1 September 2017

GUEST ARTICLE: The Value Of DFMs As Markets Reach New Highs

The value of discretionary wealth management might start to win over new converts if or when levels of equities reach the edge of the stratosphere, this article argues.

More than nine years since the 2008 financial crisis, stock markets and certain other assets have fared well (perhaps confounding some investors), but there is increasingly plenty of commentary about when, not if, equities have one of those jarring “corrections”, given how long in the tooth the bull run has been. In such an environment it pays to consider approaches to managing wealth that go beyond current fashions, such as for passive investment. 

With such thoughts in mind, here is an article by Craig Melling, investment manager at Progeny Asset Management. The views of this author are a valuable contribution to debate; the editors of this news service don’t necessarily share all views of guest contributors and invite readers to respond. Email

Nearly 10 years on from the financial crisis and equity markets are once again testing their highs despite a backdrop of worryingly complex geo-political risks, the like of which we haven’t experienced since end of the World War 2. Having reaped the rewards of a long-term bull market, investors are beginning to contemplate how best to now seek performance and yield in a continuing low interest rate and increasingly fully valued marketplace. 

The US is at the heart of this discussion. “Trumpenomics” has helped the S&P index to successive all-time highs. The carefully watched Shiller P/E [measure of stock valuations] is 30, compared to a historical mean of 16.8. However, the tailwind of Trumpenomics is uncertain: tax reform seems a long way off, given the gridlock in congress, and the much vaunted government infrastructure program is yet to get off the ground. Meanwhile the signal from the US Federal Reserve is clear: the period of quantitative easing is now over. 

Here in the UK, the FTSE 100 trades on a P/E ratio of 21 times earnings, higher than its historical average of 15. The FTSE 250’s recent high seems to be highlighting the resilience of the UK economy.  However, Brexit is casting a dark cloud over expectations, despite growing company earnings and weaker sterling supporting revenue, especially for the FTSE 100.  

The increasing popularity of the passive fund management industry, including index trackers and ETFs, has also eaten up market share. In Europe these each have 6 per cent of market share by assets under management with around £580 billion and £627 billion respectively, according to data from Thomson Reuters Lipper. Moody’s has this year claimed that the passive industry could overtake the active in the US by 2014. 

So what is an investor to do?
Discretionary fund managers are well placed, at times like these, to provide good advice based on the sound principle of “get rich slowly”. They understand the dangers of the consensus view as much as the risks of following current investment fashion. They equally can warn against the erosive effects of reckless conservatism. Bluntly, they know that the true value of a portfolio’s structure is how well it withstands a downturn.  

DFMs prove their worth, and ultimately earn their fee, by utilising tactical asset allocation, judicious underlying fund selection, and superior stock selection.  It has been easy in the “good times” (since 2008) to make solid returns simply by buying an index tracker or ETF. As markets moved further up these have looked unassailable. But they are not infallible, since markets do not keep rising in a straight line indefinitely. So just when active management looks at its most anaemic next to index tracking, this is the time to re-look. A good DFM will stand out against the crowd in this way.

DFMs are equipped to do the leg work of assessing a portfolio’s volatility and how this stands up against the objectives of the investor and his or her risk tolerance. While a portfolio shouldn’t need constant (and costly) changes in holdings, it does require constant monitoring.  

Even when asset prices are high, a DFM will know that the cost and risk of coming out of the market completely is unlikely to work over the long or even medium term.  Markets can stay highly priced for years, and in the meantime the portfolio passes up the dividend flow from equities and coupon flow from bonds. Then there is the question of when to re-invest, and the cost of doing so. If the investor doesn’t need the cash, a market fall and recovery over months becomes irrelevant (2008 saw a substantial market fall, but the recovery from April 2009 was rapid and powerful). In the meantime the income continues to accumulate.

An actively managed discretionary portfolio can exploit mispricings on the upside as well as the downside. Oversold sectors may remain so for months or even years, but when the sentiment turns valuations will climb fast. Similarly overbought assets may look good for longer than they deserve to, but buying a blockbuster fund after it has become bloated on earlier success is seldom a recipe for good returns - Invesco’s Growth & Income and Aberdeen’s Asia Pacific fund have taught us these lessons, and Standard Life’s GARS fund looks like it is repeating the cycle.  

Cost is an important consideration though. Low-cost DFMs with transparent pricing will have the advantage. High costs too frequently erode the benefits of active management and net performance can trail the broader market. The industry’s transition to a lower cost model will only accelerate as we enter a lower-return environment, particularly in light of greater Financial Conduc Authority scrutiny of fee structures.

As an industry, we also need to rethink active management and help educate investors about the different roles active managers can play. While investors typically think of active management as stock picking, active managers can also add value through asset allocation across passive instruments. This can often be cheaper than pure active strategies, all while enhancing returns and risk profiles for investors.

As markets reach new highs and central banks begin to take away the punchbowl, it’s time to reconsider the balance between active and passive investment strategies. With greater divergence between the performance of different assets, the right cost framework, and a more flexible approach to the role of active managers, there will be more opportunities for active managers to deliver market-beating returns.  

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