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DFMs' make-or-break bond calls; A tale of two manager exits

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Make-or-break bonds

Our recent work suggests DFMs aren’t exactly overdiversified when it comes to risk assets: many run concentrated portfolios, the effect of which is only amplified by a preference for equity fund managers who double down on their favourite holdings. But the fact DFMs have ballast within portfolios suggests this isn’t as make-or-break a strategy as it seems.

Among other things this comes down to bond exposure. For a closer understanding of how DFMs are positioned, we’ve looked at the average number of holdings in the 10 most widely held bond funds from each sector. We’ve omitted gilt funds from the analysis, given wealth firms are predominantly using passives.

It's no surprise bond funds are worlds apart from their equity equivalents when it comes to diversification: the risk/reward dynamic facing a fixed income manager rarely favours a concentrated approach. Other factors, such as the fact managers can buy more than one holding from a preferred issuer, make bond funds more likely to spread out the exposure.

That's good news for DFMs: the level of diversification here means there's suitable ballast to the more gung ho approach within equity allocations. But the differences between bond groupings might raise some eyebrows.

Short duration funds understandably take a more concentrated approach. Managers play it safer when it comes to dedicated credit vehicles, though there's not a huge diversification gap between corporate bond funds with different levels of risk. When two Nomura funds with particularly large numbers of holdings are stripped out, the high yield average actually sits slightly below its corporate bond equivalent. Strategic bond funds might be able to pick riskier credit, but many hedge their bets via bigger portfolios.

EMD's a different story, with DFMs' favoured managers running much more concentrated portfolios. There could be several reasons for this: the limited size of the EMD universe, or just the need to be selective here. But it's something for DFMs to keep a wary eye on when considering their diversification needs.

Zero sum

Those with a healthy scepticism toward the long-running equity bull market have never needed look far for a bogeyman. For now we're back to an old favourite in the form of trade war tensions: markets look somewhat calmer this morning on signs that frictions have eased slightly, but not before a hefty sell-off in the chipmaker sector.

Events might help drive indices up and down, but it's also good to remember investors act as another brake on the market getting carried away.

That’s one take from the latest Morningstar fund flow estimates. The figures do show that some equity funds fared well by sales, particularly those run by DFM favourites such as Lindsell Train and Merian. But on aggregate stocks remain firmly out of favour, with equity funds managing less of a showing among the most bought products for April than on other occasions.

Equity’s loss is fixed income’s gain, with several bond funds among the most popular names for the month. But it’s worth noting the presence of some short duration products among these, suggesting the enthusiasm for fixed income isn’t just down to investors betting on a further fall in yields.

Broader moves aside, fund news still has the power to influence investors. That’s evident from a look at Janus Henderson Emerging Markets Opportunities, which has suffered outflows following the news that Glen Finegan and team were headed for the exit a few weeks back.

Not all manager departures have the same effect. JPM Global Macro Opportunities manager James Elliot might have left the firm but the fund remains among the most popular names in the latest estimates.

Safe pair

Discretionaries with punchy equity positions have plenty to worry about, but life is far from rosy for less sophisticated investors. For proof, just look at the FCA’s latest missive on crypto and foreign exchange investment scams, which saw individuals lose £27m in the last financial year.

The story is a well-known one: bogus ventures lure investors in with promises of a get rich quick scheme that can only end painfully, resulting in a crackdown later on. But for the professional investment crowd it’s worth considering the other consequences.

For one, there’s the classic threat to the investment community: if individuals fall prey to scams on their first attempt at investing, it can scare them away from backing conventional assets in future. Investment professionals can only hope they are not tarred with the same brush, and can benefit from backing a more traditional approach.

That said, there might be a silver lining. We’ve noted before that Mifid disclosures will increasingly force DFMs to justify the value of their services. Against the backdrop of less reputable alternatives, there should be a case to make.

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