How allocations changed in Q3

​As the dust continues to settle on October's drama, it's getting a little easier to take a step back and reflect. That can mean thinking about the past as well as the future, so we've compiled figures from our asset allocation database to show exactly how DFMs had positioned their model portfolios in advance of the sell-off.

The two primary findings suggest that discretionaries have diverged from peers in their recent choices. The shift away from the US discussed in some quarters over the summer was in direct contrast to DFM activity. And nor have wealth managers continued the move away from UK equities seen among both market professionals and retail investors lately.

The third quarter isn't typically a time for huge asset allocation shifts, and a regular rebalancing of portfolios can also make changes hard to discern. But we can see the typical wealth manager was content to let their US exposure drift higher rather than holding fast as the rally continued. The average weighting ticked up from 13 per cent to 13.5 per cent over the period:

By contrast, DFMs felt the need to intervene as domestic shares continued to struggle, topping up exposures to ensure average allocations remained static at 20 per cent.

Hardly in keeping, you might think, with the continued outflows from UK equity funds over the period. But those redemptions are almost entirely due to a handful of out-of-favour portfolios which DFMs exited some time ago. So our Q3 findings bolster the idea that domestic sentiment isn't as bad as claimed in some quarters. 

But overall equity exposure did fall back on the quarter. That's because a paring of European positions more than offset the increase in the US. Concerns over Italy and European economic data in general were on the rise over the summer, and the average weighting to European shares fell from 6.9 to 6.3 per cent. 

This slight shift away from shares was accompanied by an increase in alternatives weightings, suggesting that wealth managers might have become more coy about risk asset valuations after all. The prudence of that decision quickly became apparent last month.​

Skipping the value rally

It was a tolerable sell-off for value investors. Indices at least outperformed their growth counterparts in October, again raising a flicker of hope that the style might come back into favour.

But it will prove just one more false dawn if Merian equity boss Ian Heslop's theory plays out. As FTAdviser reported amid the turmoil, the manager thinks markets could bypass the value rally altogether:

Heslop said US interest rate rises, concerns about the health of emerging markets and other geopolitical uncertainty meant markets may skip the value stage and move straight to caution.

It's just an idea, but one worth considering for DFMs with a wary eye on their positioning. And the data does lend weight to the suggestion.

MSCI's ACWI Defensive Sectors benchmark lost 3.5 per cent in October but held up slightly better than its Value Weighted counterpart, which shed 4.9 per cent.

The defensives benchmark even outperformed the value index for the first nine months of the year. That's probably because the equity rally is long in the tooth at this point. Few investors would deny their fear is that change, when it comes, will be less of a simple style rotation and more like the kind of collapse seen last month.

Viewed in this light, the lack of 'real' value funds that we discussed a couple of weeks back is less of a problem for selectors. Running for cover is never a happy decision, but wealth firms will at least have little doubt about where to find those defensive managers.

Passives remain a closed shop

We wrote yesterday about the role passives play nowadays in DFMs' equity allocations. That presence is dominated by a handful of big providers, chief among them Vanguard, iShares, L&G and Fidelity. 

Not surprising, given the importance of scale in bringing headline prices down for fund selectors. But there are also signs of a few second tier - if not exactly small - names making headway among fund buyers. SPDR, Invesco/Powershares and db X-trackers have all managed to gain a foothold, according to our MPS tracker.

You might expect more of the same when it comes to bond allocations, given passive usage here has only really started to take off over the past few years. In reality, the opposite's the case: holdings are concentrated among just three big players (it's iShares, Vanguard and L&G again). 

The gap to the next largest firm by number of DFM picks, Lyxor, is significant. And the rest are having to be content with the scraps. Further evidence that the "passive price war" seen over the past half-decade is already over, and the winners and losers already decided.