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Asset Allocator

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Discretionaries' biggest bets under the microscope; The latest diversification dilemma

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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Going large

Conviction investing means a lot of things to wealth managers, but often it boils down to just one: concentrated holdings. As we discussed last month, small positions just aren’t that common in DFM portfolios. Couple that with the relatively small number of holdings in the typical portfolio, and it suggests wealth firms have a preference for bulking up average weightings.

A closer analysis confirms that suspicion – albeit with several caveats. The chart below shows the spread of biggest portfolio positions for a range of DFMs in our database:

Many discretionaries are happy to go all out when it comes to their top positions. While most stick to single-digit exposure, every wealth manager has opted to put at least 5 per cent on the top holding - and those on the left of the chart often have several 5 per cent positions. Seven firms have gone for 10 per cent or more in a single strategy.

What's also interesting is where DFMs have built up large positions. For many, the largest position in a Balanced portfolio is in a US equity tracker - suggesting a building block approach - but there are exceptions.

A couple of wealth managers, for instance, account for their entire alternatives exposure in the form of a go-anywhere absolute return fund. Others are content to stick seven per cent or more in a single active UK equity manager. One particular fund in the strategic bond space is also popular: two DFMs have Janus Henderson Strategic Bond as their biggest position. But most big fixed income bets are usually still short-duration in nature.

One DFM in our sample uses in-house funds as a big chunk of its portfolio – but there’s little evidence of this becoming a wider trend. And, perhaps contrary to received wisdom, there’s no obvious correlation between having a smaller number of funds and bigger individual positions: many of those on the right of the chart have as many individual positions in their portfolios as those on the left.

Correlation drift

As investors flee to fixed income safe havens, and sovereign bonds thereby prove their worth again for asset allocators, it’s worth considering DFMs’ own diversification in a little more detail.

We mentioned last week that plenty of wealth managers are still gaining government bond exposure via strategic bond funds as well as conventional fixed income positions. Equally, as the story above indicates, these positions are often short duration in nature.

Of course, nowadays many favour alternatives, rather than bonds, as their diversification tools of choice. The problem is that when it comes to the largest pool of alternative offerings - absolute return funds - recent years have seen a gradual shift away from bonds and towards equities.

Correlation figures from FE draw this out. On a five-year view, the correlation between the average absolute return fund and a typical global or UK equity fund stands at 0.7, where 1 is perfect correlation. The stresses and strains of recent times have tested this relationship: over one year, the absolute return sector now has a correlation of 0.9 to its equity counterparts. At the same time, its correlation with UK gilts has started to dwindle.

This will be partly due to the number of equity-heavy funds in the asset class - long/short strategies are designed to provide a measure of downside protection, but the majority remain net long risk assets. But a correlation of 0.9 is arguably too large to ignore at the moment. 

Discretionaries can at least take solace from the fact that direct property is still holding up relatively well as a diversifier, per FE data. But here too correlations with equities have begun to creep up, albeit from a very low base. In times of trouble the old-fashioned 60/40 portfolio is still proving hard to beat.

Retirement ravings

Perpetual political chaos means the government has devoted very little time to other pressing problems of late. And one policy proposal being floated today suggests that silence was golden.

Allowing first-time buyers to dip into their pension pots for house deposits looks like a classic example of cutting off noses to spite faces. Putting all other questions aside, derailing one of the most encouraging developments of the past decade - the rise of auto-enrolment - looks foolhardy in the extreme. 

Wealth managers (and indeed their typical clients) are often one step removed from those struggling to get onto the housing ladder. But they know better than most that short-term solutions have little role to play when it comes to retirement savings. There will be no shortage of people rushing to point that out in the coming weeks - they'll hope this is one policy destined to be lost in the mix come the next inevitable reshuffle.

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