Simon Ellis, global head, client segments, HSBC Gam
As head of the wholesale segment for HSBC Gam, it’s Simon Ellis’s job to look to the future and not dwell on the past.
“If we look at the European landscape, there has been a notable shift in terms of the sorts of funds and products that people are allocating to,” says Ellis.
After a tough six months for the industry, he clearly thinks this is the way forward.
“What we’ve seen is a shift towards global products and away from regional allocations, especially in the equity area.”
And he doesn’t believe this is a short-term trend. He explains that a typical discretionary manager separates their portfolios into buckets: one for equities; one for fixed income; one for alternatives (now increasingly likely to include illiquids); and so on.
“Investors want to know where they can get the last extra piece of juice out of this bull run.”
Traditionally, discretionary managers bought global funds only when they were looking for specialist assets, which they hoped would provide some kind of diversification from more traditional segments.
“But what’s happening now is that global themes are seeping into the parts of portfolios previously reserved for traditional equity strategies,” he says. “We’re seeing a lot of rotation out of what you might consider as the regional core, like European or US large-cap equities, into thematics.”
Notes on a theme
This move towards more thematic investing is being driven by investor concerns about the basic building blocks that form the core of their portfolios, particularly developed market equities.
Expert Investor’s in-house research reveals fund buyers across Europe have been attempting to reduce their US and European equity exposures for the past 18 months (go to fundbuyerindex.com for the picture on all the other asset classes).
In the immediate term, these worries are about valuations and late-stage cycles but there is also longer-term pressure to move away from regional investing. The correlations between all major asset classes is very high, partly because all big companies, wherever they are domiciled, are international and therefore hit by the same macro factors. Also equity and debt from these companies are traded by the same dominating group of international investors, so the prices lock together.
According to Ellis, whatever the reason for that trend, it creates difficulties for fund managers because they want people to remain invested in something.
“You want investors to keep assets in funds rather than cash,” he says. “Even if you’re a bank, you don’t want to tell clients to put money into cash because you’re not necessarily trying to build up the cash balance sheets these days.
“But in a late cycle, valuations appear stretched in core asset classes. A lot of fund buyers, and their smarter clients, say ‘this has been a long bull run and it’s going to crack sometime.
“I don’t know what the catalyst is going to be, but it feels closer now than four years ago’. So there is an underlying nervousness about those traditional assets.”
HSBC does a review every quarter of all the major global private banks client newsletters, which throws more light on this.
Over the past few months, a very close consensus of the macro picture has developed. “They say central bank rates are unlikely to move aggressively upwards,” notes Ellis.
“One of the fuels for that bull run in the first half of 2018 was a continuation of the neutral monetary policy. “In the second half, things were tightening. However, while the direction was clear, the pace and level were not.”
In general, there has been lots of uncertainty macroeconomically, while there has been a huge amount of noise in the background: Trump, China, trade wars, Brexit. Ellis summarises: “There are a whole bunch of reasons not to be cheerful.”
Yet the nervousness has eased during the past two months. The HSBC private bank survey reveals the advice offered in most newsletters is to ignore the noise and not worry too much; the markets are still connected to the economy and, while the economy might not be great, it’s OK – so there is no need to panic.
The graph below shows there were big outflows of everything bar money market funds from September to December 2018, flows that have since gone net positive. February is the latest Morningstar data at the time of writing.
Money is going back into funds but, according to Ellis, what investors are looking for in this late-cycle stage is alpha-generating options. “They want to know where they can get the last extra piece of juice out of this bull run. To do that, you have to find things where the underlying growth story looks more compelling than just a general exposure to risk assets.”
As a result, this has necessarily pushed professional investors into finding more niche areas to invest in.
There are two ways to approach this: one is to find technically challenging investment strategies that make money through their sophistication; and the other is to find things that are easy to understand but just happen not to be mainstream. It’s the latter approach that is winning.
“It’s like buying a modern car,” says Ellis. “Open the bonnet and I don’t want to touch anything. I’m not even going to plug my laptop into it to do a self-diagnosis.
“A lot of what we do now is a bit like that. It’s smarter, it’s better engineered, there is far more quantitative skill involved than there was 10-15 years ago. But for customers, that is quite dry. We want them to still feel engaged in what is going on.
This brings us back to thematic investing. Themes give a narrative scaffolding to an investment story, one that is understandable to the unsophisticated but still relevant to investment experts.
“It’s a human thing,” says Ellis. “It’s easier to respond to a story than to a micro-analysis of global macro forces and relative valuations or Sharpe ratios. The technical stuff that we find fascinating, to a consumer is just an outcome.”
These thematic stories are growing in importance, particularly in the advisory and direct-to-consumer channels, says Ellis.
A number of private banks have started inviting their clients to regular seminars where they meet captains of industry in various emerging technologies, so they can hear from industry practioners.
“Take Elon Musk,” says Ellis. “Imagine 25 people in the room worth $10m each and he talks for half an hour about the dynamics of driverless cars, electric vehicles and where we are in terms of extending the journey time for battery life, etc. That’s the sort of thing people will get, and be able to understand the opportunity in that sector.”
According to Ellis, the move towards story-driven investment sales started in the advisory space but has now moved into the discretionary space, too.
“Just because you are very sophisticated doesn’t mean you aren’t inspired by the same stories. The only difference is that you’ve got the wherewithal to participate in more of them and you may have access to better quality information.”
To persuade any investor to put money in a fund, you still need to appeal to their more technical aspects – showing them correlations and fund behaviour in different market conditions. But when it comes to appealing to the end investor, the most vital question, says Ellis, is: “What’s the story?”