Goldilocks and the dollar

The unease that’s lingered throughout the 2019 equity market rally has started to become a little more palpable lately. Returns are still heading in the right direction, more or less, but there are signs these rises are starting to peter out in the face of trade war tensions.

After the twists and turns of the past 18 months, few wealth managers would be surprised if another tougher period now emerged. But familiar as it may feel, that doesn’t mean the impact on portfolios will be straightforward. 

As GaveKal Research points out, the latest angst over trade negotiations is having a rather different effect this time around. In short, the US dollar “seems no longer to be reacting to risk-off moves in the same way”. 

Last year investors were concerned about further tightening from the Federal Reserve, this year they’re starting to price in rate cuts. As of yesterday, futures were predicting a near-90 per cent chance of a rate cut by next January. That’s quite the turnaround from last autumn, and could have implications for everything from gold to emerging markets.

It’s EM that is arguably the most interesting question here. Emerging economies, particularly in Asia, are still being buffeted by the fallout from trade war - though not everyone is a loser, as we highlight later on in today’s newsletter. But there are still outcomes in which the trade war can worsen and yet EMs can prosper. 

Gavekal thinks two subtly different scenarios could be vying for investor attention in the coming months. One would see a looser Fed combine with a lower oil price (driven by drooping Chinese demand) and a struggling dollar to boost other commodity-dependent emerging markets.

The second is more familiar: the lower oil price will be accompanied by only a slight dovish shift from the Fed, and a relatively range-bound dollar. It thinks that would result in a continuation of the ‘goldilocks’ environment in which big global brands with clear earnings streams remain the focus of investors' interest. Wealth managers are well positioned for the latter outcome - the former may be worth considering more closely, too.

A path emerges

As it stands, a few DFMs have begun to pare back their EM allocations. These are still relatively minor moves, but as we discussed last week, other investors are proving rather more flighty. Trade tensions mean healthy enough year-to-date EM returns have nonetheless lagged those seen in other markets.

When it come to equity funds, we shouldn’t forget that discretionaries nowadays tend to separate Asian allocations from broader EM exposure. And positions in the former asset class are still gradually creeping higher for now.

The question is, will wealth firms be able to take advantage of the big EM/Asian equity rally - if and when it does arrive?

On one level, absolute allocations remain pretty low: the total EM and Asian equity fund exposure in the average balanced fund still sits just below 10 per cent. And unlike other asset classes, there’s very little deviation from that mean. Only three firms in our entire asset allocation database have weightings of 14 per cent or more in their balanced models, and none has more than 16 per cent.

As ever when it comes to MPS, this is partly a tale of benchmarks. While bespoke portfolios may be more adventurous, when it comes to models many DFMs have one eye on Dynamic Planner allocations - which, at around 10 per cent in EM and Asian equity funds, are still a little higher than the average balanced model - and the other on WMA indices.

It’s in relation to the latter area where a rally could really benefit discretionaries. We’ve spoken before about the risk-on nature of the WMA benchmarks, but they’re pretty light when it comes to emerging markets: the private investor balanced index doesn’t have much more than 5 per cent in the asset class. If EM does start to take off, wealth managers could quickly find themselves with a structural advantage.

Down we go

With plenty of competition in the multi-asset space, Vanguard’s LifeStrategy funds have continued to dominate, not least because of their low-cost approach. But the arrival of a new competitor suggests the dynamics may be shifting.

BlackRock’s newly launched MyMap funds will charge an annual fee of 0.17 per cent – undercutting Vanguard by five basis points on headline charges. LifeStrategy still has the cheapest all-in-all cost for those who want to use Vanguard's own platform. But for the average investor, this is another sign that multi-asset investing is getting ever cheaper.

Shaking LifeStrategy’s grip on the multi-asset market will be far from easy, BlackRock’s offering might appeal on another front: the fact it can invest in the likes of gold and real estate makes it slightly more diversified than Vanguard’s offering, which restricts itself to stocks and bonds.

For DFMs it’s a reminder that competition on costs isn't going away – and that they would do well to focus on standing out from the pack however they can.