Safety, in numbers

The days of making a simple choice between equities and bonds are long gone for wealth managers - and other old certainties are also becoming more complicated than they once were.

It goes without saying, for example, that overall equity allocations should increase as DFMs move up the risk spectrum - and vice versa. But the exact make-up of those allocations doesn’t always follow quite such a linear pattern.

Following our look at equity allocations in Aggressive model portfolios, we’ve given Defensive offerings, or those with a risk rating of 3 from Dynamic Planner, the same treatment. The results are below:

On the face of it, this can be taken as a simple paring back of equity allocations at the lower end of the risk scale. No weighting exceeds single figures, and domestic stocks and US equities remain DFMs’ principle areas of interest. But there are other stories to tell beyond these core exposures.

Defensive models do make the obvious choice and cut back on those areas perceived as being highest risk: emerging market and Asia ex-Japan equity weightings are reduced by a greater proportion than any of their counterparts. UK small-cap exposure, too, almost entirely disappears, albeit from a low starting point. 

Indeed, diversity in general suffers a little. European and Japanese exposures are little more than one per cent of a portfolio apiece. It’s probably for this reason that global equity funds - not typically a popular choice among wealth managers - have carved out more of a presence in Defensive portfolios. The average weighting here, at almost 4 per cent, isn’t that far removed from the 7 per cent held by Aggressive models. 

DFMs clearly think that a generalist exposure makes sense for more cautious investors. But low-risk shouldn’t automatically mean less sophistication, or sacrificing specific exposures for the sake of simplicity. Wealth managers should think carefully about whether they’re short-changing their less gung-ho clients.

A Chinese puzzle

The parallels between early 2019 and early 2016 keep on rising for wealth managers and other asset allocators. March’s fund manager survey from Bank of America Merrill Lynch hammers that point home. Concerns over secular stagnation are back at the fore, investors are again favouring defensives that do well when growth stumbles, and fears of a Chinese slowdown have increased once more.

But it's only recently that the most important resemblance of all has started to emerge. When we wrote about these similarities back in January, there seemed little sign that China was about to embark on a fresh round of stimulus. 

A few weeks later, signs are different: premier Li Keqiang, known to be against Beijing’s reinflation policies, admitted earlier this month that help is on the way for the economy. That might take a more nuanced form than in the past, but it will probably prove good enough for investors either way. 

Which brings us to the latest paradox in the fund manager survey. 

The phenomenon of crowded trades that aren’t that crowded remains in place - short European equities is now seen as the consensus bet among fund managers, but once again “conviction is low”. Views on China are more contradictory still: a Chinese slowdown may be the biggest tail risk, but there’s also been a big leap in the proportion of investors expecting stronger Chinese growth over the next 12 months.

The suspicion is that fund managers are again banking on Beijing’s policymakers to releverage, and thereby buoy global markets again. In the meantime, few are making big calls: Baml says there are “no extremes in sector positioning” as it stands.

Molehills

The current uneasiness has that late-cycle feel to it, but nervy investors are nothing new in this bull market. There have been plenty of dogs that didn’t bark amid the ongoing attempts to spot the next shoe to drop. BBB debt remains in that category for now, even if there are plenty of rumblings behind the scenes. 

The news earlier this week that Kraft Heinz’s debt has been put on review for a possible downgrade by S&P seems like another warning sign. But the food giant’s $31bn debt pile still looks safe for now. It’s rated one notch above junk by both Moody’s and Fitch, but slightly higher by S&P - and the latter says it’s unlikely to downgrade the firm by more than one rung.

And as it happens, downgrade warnings are starting to fall out of fashion. Goldman Sachs analysts point out that the amount of BB debt on review for upgrade in the US now exceeds the amount of triple-B bonds slated for downgrades for the first time since the crisis. The current cycle might have further to run after all.