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A safe port in the storm; What's happened to the UK income stalwarts?

Welcome to Asset Allocator, FT Specialist's newsletter for wealth managers, fund selectors and DFMs. We know you're bombarded with information, so each day we'll be sifting through the mass to bring you what you need to know, backed up by exclusive data and research. 

 

A port in the storm

​A tough market always punishes profit misses more harshly, and there's plenty of evidence of that this morning. WPP was already out of favour and its third quarter update hasn't helped matters.

The advertising giant pointed to a fresh slowdown in client spending and its shares are down 16 per cent as a result.

A handful of managers do still back the stock: GVQ held more than 8 per cent of its UK Focus and Opportunities funds in the company coming into October, while Jupiter UK Special Situations had a 3.7 per cent position. And it's a sign of how far WPP has already fallen that it now makes up 2.5 per cent of the Dimensional UK Value portfolio.

The pain's even worse for small-cap environmental consultancy RPS. Its disappointing third-quarter update has pushed shares down some 30 per cent. That has likely hurt its Neptune UK mid-cap and Franklin Templeton backers, and Morningstar data also notes Unicorn UK Income had a 2.4 per cent position as late September.

While the UK has avoided the kind of fall seen in the US overnight, it's another tough day for equity markets. So best to end on a positive note, with a trading update from Relx. The company said this morning that its full year outlook is unchanged - the kind of dull reliability that makes it so valued by a number of growth and income managers.

Relx hasn't done much over the past 18 months, but it hasn't suffered materially, either. It's off just 0.5 per cent today, and the chart below shows just how significant it's become for some of the more prominent names on wealth manager buy lists.

 

Growth and/or income

How can you tell the difference between a growth fund and an income product? The answer should, of course, be in the name.

But rising markets (until this month, at least) have meant compressed yields. Add to that changes made by the Investment Association to its sector rules and the dividing line is not so clear cut nowadays, according to research provider Cerulli.

Here's Andre Schnurrenberger, its managing director for Europe:

The lowering of the 110 per cent index yield threshold would appear to blur the distinction between an equity income fund and others, although some might argue that it was never very clear cut.

Equity income is big business, but the picture isn't particularly rosy right now: IA UK Equity Income, once among the largest three fund groups, suffered £1.7bn of net retail outflows in the 12 months to August 2018.

Those redemptions are partly because the stalwarts of the sector just aren't so popular any more. Neil Woodford's travails are well known, and just three wealth managers in our database still hold his flagship income fund in their model portfolios.

What's arguably more surprising is that Mark Barnett's Invesco Perpetual Income and High Income funds are now no longer held by anyone at all, according to our tracker.

Another stalwart, Adrian Frost, still has a decent following: Artemis Income is the joint most popular fund in the sector, with 10 firms holding it, though these tend to be smaller wealth managers rather than the bigger DFMs. Other high profile names still retain support but have struggled to maintain performance in the face of the UK equity market shifts this year. 

Cerulli's yield concerns aren't necessarily borne out by the data, however. Four of the five most widely-held funds yield more than 4 per cent, suggesting income can still be found in the right places. And there'll be a few more areas to hunt in once the dust settles on October's slump, too.​

Hedging bets

With sterling still at the mercy of the Brexit negotiations, some might say there's little point in UK wealth managers hedging currency exposures at the moment. Sure, the pound may still be down by double digits versus the dollar, euro and the rest since summer 2016. But with even the softer (ie pound-positive) Brexit deals now looking like they may be transitional rather than permanent in nature, backing a rally looks tough.

Set against that is the fact that hedging remains an important risk management tool in the bond space in particular.

Hector Kilpatrick, CIO at multi-asset specialist Cornelian, notes that all his firm's fixed income fund holdings are hedged on a share class or portfolio level for this exact reason. Others have similar motivations.

Here's Ben Seager-Scott of Tilney:

I would tend to favour unhedged share classes for equity fund exposure and hedged for fixed income and alternatives. Basically, if the currency volatility is generally greater than the underlying asset class, I'd be minded to hedge.

Many internationally-focused bond funds tend to hedge their currency risk at the portfolio level, meaning hedged share classes aren't usually necessary. So it's in keeping with the comments above that such share classes – typically used for equity funds – are few and far between within our model portfolio database.

That said, there are other complications emerging, even on bond funds. Interest rate disparities between the UK and the US are creating problems for buyers – we'll have more on that in the coming weeks.

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