Growth via income

Assumptions are dangerous things, but they're not entirely without merit. Take model portfolio composition: it's fair to assume that equity exposure rises as you move up the risk scale. It also makes sense to see a move into growth strategies at the expense of income.

These theories might be correct, but there are nuances that can be missed. And a growing trend, particularly in light of dividend-paying stocks' recent performance, is wealth managers' propensity to include equity income strategies in their higher-octane portfolios.

To illustrate that, the chart below takes a sample of DFMs' most aggressive portfolios and ranks them by their use of dividend-focused strategies:

The blank section on the left of the chart shows that many do still have reservations about using yield-oriented funds in Adventurous portfolios.

But as the right-hand side shows, plenty of others do back income names, with five having built up double-digit weightings. Understandably, those with bigger allocations tend to spread these across a few names by holding at least three income funds. 

When it comes to asset classes, it's not entirely about equities. Like Income portfolios themselves, aggressive offerings do inevitably favour shares over anything else. But there are also a handful of multi-asset funds included.

That said, we have excluded fixed income holdings from the chart. The inclusion of, say, an emerging market debt fund in an adventurous portfolio would raise few eyebrows. 

But why exactly are equity income funds being held in these strategies? It's not simply because certain dividend-paying stocks have been on a tear in recent times. As Parmenion investment manager Jasper Thornton-Boelman summed up last year:

Ensuring a continued allocation to [both income and growth funds] helps maintain discipline within our solutions and reduces the risk of performance being driven by style rather than stock selection.

For many discretionaries, maintaining that balance is crucial even when it comes to the most gung-ho portfolios.

Prospecting plans

A handful of income strategies feature on Morningstar’s semi-annual tally of fund ‘Prospects’, the latest edition of which was released earlier this year. Four months on from that, and those hidden gems remain unearthed by DFMs.

Of the 47 funds identified by the data provider - strategies which it doesn’t currently rate but that are promising, unique and/or deserve a wider audience - just nine currently feature in our database of DFM fund selections.

Those nine are almost entirely confined to the equity space, the sole exception being the Westwood Global Convertible fund. Of the group, only two, Polar Capital Biotechnology and Jupiter Asian Income, have a presence in more than one wealth manager’s model portfolio range.

A buy list can only hold so many funds, of course - and as Morningstar notes, there are 40,000 funds to choose from in the cross-border European open-ended fund universe alone. Remove the options that sit in niche asset classes (German equities), and the multi-asset funds that are essentially doing the same thing as wealth managers’ own portfolios, and that leaves around 20 unused funds on the prospects list.

Nonetheless, this isn’t the first sign that discretionaries aren’t always willing to take the plunge with an unheralded strategy or two.

Structural issues, such as the increasing centralisation of buy lists, may be partly to blame. Similarly, in the world of MPS, a relatively small number of underlying holdings leaves less room for experimentation. But the opportunity cost of sticking to the tried and tested routes might just become more apparent as risk asset returns start to diverge once again.

Taking stock

Talk of diverging returns and one particular asset class still comes to mind: US equities. North American stock markets have comfortably outperformed peers this year. But as Capital Economics observes, renewed trade war jitters have now started to curtail those relative returns.

Notably, this wasn’t the case when worries about tariffs reared their head last summer: US shares continued to rally even as other areas struggled. 

Yet the forecaster thinks this was as much to do with earnings as the perceived resilience of the US to any trade war flare-up. It thinks the US economy is now deteriorating, and with no repeat of the 2018 corporate tax cuts on the horizon that could spell trouble for US indices. Capital is far from the first to make that call, but if nothing else it does point to the growing uneasiness starting to creep into investors’ minds once again.