Asset AllocatorJan 31 2019

Wealth firms' struggle to protect portfolios; A historic shift for UK equity income

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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. 

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On the defensive

Whatever happens in the next few months, DFMs are likely to look back at January with fond memories. An uneventful start to the year has given investment managers the chance to regroup after the bumps and bruises of Q4.

In some cases this has meant snapping up bargains, but its also been a time to check how downside protection strategies have worked. 

Nowadays it’s not quite so easy to work out what exactly a defensive asset is, of course. To cut to the chase, we’ve assessed the asset allocations of DFMs’ defensive model portfolios - ie all those with a risk rating of 3 on the Dynamic Planner scale.

On an aggregate basis, bonds still dominate risk-averse approaches. And the difference between these mandates and even balanced counterparts is stark: defensive portfolios are holding twice as much in fixed income.

What’s more, individual weightings are fairly clustered around the average allocation of 42 per cent: just one wealth manager has less than 25 per cent in the asset class, and few even dip below 30. 

That approach may unsettle some, but it’s worth noting that DFMs’ bond exposure is more nuanced than it once was. And there is recognition of the need to diversify - though an average cash weighting of 10 per cent is lower than you might think.

A related problem is that many are unpersuaded by the value of alternative assets, such as absolute return funds or property, as defensive plays. The average portfolio does have a quarter of assets in this bucket, but that’s not much more than balanced portfolios’ 16 per cent allocation.

These strategies did a good job of protecting portfolios at the end of Q4, but blow-ups in the absolute return and hedge fund space have run patience thin in some quarters. Absent a change of heart, defensive portfolios are going to look fairly old-fashioned for the foreseeable future.

Active incumbents

More investors are cottoning on to the fact that UK income stocks look particularly attractive at the moment. Hargreaves Lansdown has pointed to the significant gap between 10-year gilt yields and that of the FTSE All-Share. Swap in the FTSE 100 for the All-Share and, as others have noted, that gap hit an all-time high at the end of December.

This discrepancy doesn’t automatically mean good news awaits - it could spell trouble ahead for some dividends - but it is the kind of signal that gets asset allocators interested.

Lately it’s clear caution has won out. The UK equity income sector hasn’t exactly been flush with new cash over the past couple of years. Net outflows have increased, partly as a result of the ubiquitous Brexit discount.

And there is one part of the UK income universe that hasn’t attracted interest over the short or long term. Our database of DFM fund selections emphasises that passive dividend strategies are still being given short shrift by wealth managers, even as trackers start to become the norm in other areas.

Look at quarterly flows for Vanguard FTSE UK Equity Income Index or the iShares UK Dividend ETF and it’s clear that neither has enjoyed much interest over the past decade. Add the growing concerns about dividend concentration that we mentioned yesterday and that’s unlikely to change any time soon. Certain ETFs haven’t helped themselves in recent times, either.

This disinterest extends across other regions, too: DFMs almost always prefer to take the active route when it comes to income - and they're not averse to plumping for newer entrants at the expense of tried and tested managers. 

All calm in EM

Draw a comparison that favours emerging market assets over, say, high-yield bonds, and the riposte is obvious: it’s the volatility that matters. Headline valuations or yields may look attractive, but factor in the price swings and their attraction starts to fade.

Yet the relative calm enjoyed by investors this month has been more apparent in emerging markets than developed. The 60-day volatility of EM shares has fallen below developed market stocks’ own for the first time since 2016, as Bloomberg notes. And the gap hasn’t been this big since 2011.

With currency volatility also dropping, it’s not such a bad time to be a buyer of EM. This might just be the tail wagging the dog: emerging markets were a consensus bet at the turn of the year, and volatility is bound to be muted when investors are all facing the same direction. But there’s no doubt that the Fed pause that was reiterated overnight has raised expectations of a shock-free year for the asset class.