Around the world in equity income

Worries about bond proxies and high-profile blow-ups be damned: it's still all about equity income for wealth managers. That, at least, was the conclusion of the analysis of DFM income strategies we carried out last week.

What happens, though, when all model portfolios are considered - not just those needed to generate a yield? Are discretionaries favouring equity income over equity growth come what may? A closer inspection of preferences emphasises that attitudes vary significantly between the regions.

We examined the number of equity income funds included within MPS ranges, calculating the proportion of all equity holdings they represent for their geography. The results are below:

The dividend-rich nature of the FTSE means that a strong showing for UK equity income strategies - representing nearly 42 per cent of DFM holdings for the region - is no surprise. But it's perhaps less predictable that DFMs see income as an even bigger priority within their global exposures. A dislike of generalist global growth funds is probably to blame on this front.

Japan trails well behind other regions, reinforcing the sense that, despite corporate reforms of recent years and all the accompanying hype, it's yet to become a serious income play. Fewer than 8 per cent of Japan picks have an outright income focus.

Otherwise, income funds still only account for one in every five or six fund picks, suggesting accumulation still trumps decumulation for many. But interestingly, the US - a country known for its strong capital gains rather than decent yields - is not far behind EM, Europe and Asia when it comes to the proportion of equity funds used for income. Look out for a more detailed discussion next week on why DFMs are bucking the prevailing investment trend here.

Moving down a gear

The barriers to the inclusion of investment trusts in DFM model portfolios are easy to understand, but the advantages of a closed-ended structure can be equally obvious. It’s not just about being able to gain exposure to less liquid assets: the use of gearing in rising markets has bolstered returns for many equity trust managers.

With waters looking a little more troubled, that could all change. A few weeks ago, the JPMorgan American investment trust announced it was dialling back its gearing, citing a cautious outlook. It's unlikely to be the last of its kind.

Do DFMs share this sense of caution when picking investment trusts? A look at the handful of closed-ended equity products held by ranges in our MPS tracker suggests they do - or alternatively are holding trusts for qualities other than leverage.

Fewer than 20 equity-focused trusts feature in the MPS ranges we track, and Winterflood figures show that just one of these is more heavily geared than the weighted average for its sector: Coupland Cardiff’s Japan Income and Growth offering. The trust’s gearing level comes to 22 per cent, above even the hefty 14 per cent sector weighted average.

Yet here too, the trust’s open-ended equivalent is more widely held within our database, despite lacking the ability to borrow. The same applies to Baillie Gifford’s Japan trust, whose gearing amounts to 10 per cent, and Jupiter European Opportunities.

Around half of the equity trusts in our database don't borrow at all. These names include Baillie Gifford US Growth, Downing Strategic Micro Cap, EM offerings from Genesis and Utilico, and Asian small-cap trusts from Fidelity and Schroders. If gearing does backfire amid difficult markets, DFMs will avoid the worst of the fallout.

A difficult December after all

A speedy riposte, overnight, to Monday's prediction that equities might enjoy plainer sailing for the rest of 2018: US indices closed some 3 per cent lower as trade and growth worries returned.

Much of the blame has been pinned on the increasingly divisive topic of yield curve flattening: we've already discussed the investment industry's contrasting views on whether or not that's a reliable recession indicator.

Either way, the dwindling gap between two and 10-year Treasury yields has now seen the latter fall back towards 2.9 per cent. Throw some more trade tweeting into the mix and it's enough to make the jitters return. 

One big question for asset allocators is how this might affect the dollar, and EM assets as a result. Another is how significant the US market woes will prove for other developed regions. European and UK equities are down this morning, but not to the same extent as across the pond. 

It's unlikely that they'll remain immune if the US does catch a cold, and it's also true that manufacturing PMIs in countries like Germany are just as weak as those elsewhere at the moment. But the decoupling of soaring American markets from the rest of the world over the summer arguably means the S&P has more to give back than its peers.