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Asset Allocator

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Home truths for allocators' UK equity picks; Awaiting the big strat bond shakeout

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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Home truths

For global investors, one major benefit nowadays is there's no need to care about Brexit too much. With the UK making up just 6 per cent of world benchmarks, it's easier to just ignore it and move on.

Those closer to home don't have that luxury - but they can take advantage of the depressed valuations being created by the global buyers' strike. We've documented some of that contrarian thinking recently.

There's also an old saw to consider: much of the UK market's revenue comes from overseas anyway. Morningstar took things a step further this week, calculating the typical UK equity fund's domestic/overseas revenue split. We've used some of its data to investigate how DFMs' picks compare with their benchmark and peers, as the chart below shows.

As the figure suggests, UK funds of all stripes are overweight domestic exposure when judged against the FTSE All-Share. The latter derives 28 per cent of revenues from these shores, a figure which rises to 38 per cent for the typical wealth manager fund selection. Consciously or otherwise, discretionaries' UK equity fund picks are betting on a softer Brexit outcome.

And the 10 most popular UK equity funds with DFMs appear to follow suit: an average exposure of 37 per cent is comfortably ahead of both the index and the 34 per cent average for UK All Companies funds.

But much of this figure is down to the presence of Polar Capital UK Value Opps, whose holdings derive 63 per cent of revenues domestically. Remove that and the average DFM selection is more or less in line with the sector average. So there's little sense that wealth managers are ramping up their domestic exposure more than any other active investor. 

For those that do want to go large on domestic stocks, without moving down the cap scale, equity income funds represent a simple answer. Despite their large cap bias, Morningstar figures suggest the hunt for yield has led many strategies to look to UK-focused names. All that said, the prospect of a long delay to Brexit means the downbeat sentiment on domestic companies could stick around for a while yet.

Strategic spread

We know that selectors almost always go passive when it comes to UK government bonds, but elsewhere in the fixed income world things are much more debatable. Take strategic bond fund selection: one of the few areas where passives don't, and arguably can't, make a mark. 

Crowded trades are still a prominent feature of the asset class. But for a sector that accounts for just 7 per cent of the typical Balanced model portfolio (and little more at different risk levels), fund choices do range far and wide. Strat bonds are second only to US equities in terms of the sheer number of funds that have found favour with one DFM or another, according to our database.

The array of options being used by discretionaries - the figure doesn't even include absolute return bond funds - is notable for that fact that plenty of DFMs don't use strategic bond strategies at all, preferring instead to make their own fixed income allocation calls.

So why this indecision? It has something to do with the asset class's relative immaturity. There are 90 funds in the Investment Association's Sterling Strategic Bond sector, far fewer than in the typical equity asset class. 

But unlike most equity groupings, the vast majority of strat bond funds have been launched in their current guise within the past ten years. In short, there's a much larger pool of viable candidates for DFMs: and benign conditions for sovereign bonds and credit means few have yet been tested in the way wealth managers expected.

Hotting up

Here's an asset allocation call to concentrate minds: if the world is on course to warm up by three degrees Celsius, returns for almost every equity sector will turn negative by 2030 - and get worse from there.

A research paper from Mercer, published earlier this week, draws this conclusion. A two-degree scenario would be less dramatic from an investment perspective, but still have a major impact on oil and gas stocks as well as utilities. 

The extent to which the planet will heat up over the coming decades remains uncertain, of course - though a 1.5 per cent rise is now seen as all but inevitable - but the sense that investors have been slow to react to the possible consequences is highly plausible. 

Mercer’s inevitable answer is to shift more money to sustainable investments and renewable energy assets. And whatever the decisions are ultimately made, hard thinking about these kind of questions shouldn’t be beyond the ken of investors at this point.

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