Rate rises to hit discretionary sector

Active UK and US equity managers could be overlooking an impending downturn set to engulf one of their most loved sectors, according to research by a major bank.

The consumer discretionary market has become a mainstay of many active equity managers’ portfolios and is one of the most commonly held overweight allocations.

But Bank of America Merrill Lynch (Baml) has warned the sector could be one of the worst affected by upcoming interest rate rises in the US and the UK.

Baml quant strategist Savita Subramanian said consumer discretionary stocks had historically performed poorly during monetary-tightening cycles, something fund managers needed to take into account.

“Discretionary is the only sector to lag in each of the past three tightening cycles – it is expensive and is very consensus,” Ms Subramanian said.

Baml has recommended that investors in US equities should adopt an underweight position towards the sector. But its warnings about the impact of a rate rise and the lack of a tailwind from the low price of oil translated across to UK equities as well.

The strategist added there appeared to be an ignorance to this issue by active managers, who continued to believe the low oil price and rising wages would support the sector.

But Ms Subramanian said “there is virtually no evidence of a pick-up in spending” and that rising wages actually hurt the consumer discretionary sector because it was “the most labour-intensive sector”.

In Baml’s most recent survey of global fund managers, the sector was the second-most popular for active managers.

The survey found a net 31 per cent of respondents had an overweight position in consumer discretionary stocks, just behind the technology sector in terms of popularity.

A large number of UK retail funds investing in US or UK equities have extensive exposure to the sector.

Nearly half of the funds in the IA North America sector – 59 in total – have exposure to the consumer discretionary sector of more than 12.5 per cent, which is the weight the sector takes up in the S&P 500 index.

There are 11 funds that have a significant overweight position in the sector, with it taking up more than 20 per cent of the portfolio.

While UK equity funds tend not to disclose consumer discretionary stocks, data from FE Analytics shows 24 funds within the IA UK All Companies sector have more than 20 per cent of their assets within consumer products.

However, some managers have already become aware of the issue and have started paring back exposure.