Holding firm

DFMs might often seek a first-mover advantage when it comes to troubled funds, but that’s less apparent in asset allocation. A tendency to stay the course has become increasingly embedded in discretionary manager mindsets - whether that course be a simple climb higher or a slip back onto rockier territory. 

So while May's renewed worries came on the back of four months of strong performance for risk assets, wealth managers weren't convinced there was anything to worry about. In fact, our asset allocation database shows a record-low number of changes to model portfolio weightings during the month.

But there's still some sign of DFMs recalibrating portfolios. While many have been enthusiastic about Japan in the past, that positivity has been waning this year, and several more allocators pulled back their exposure in May. A breakdown of the calls made on the region can be seen below:

The majority might have simply maintained exposure, but it's hard to ignore the quarter who brought weightings down. And in most cases, this was likely to be an active decision: in sterling terms, Japanese indices performed better than the US, UK and European equivalents during May. 

That may have come too late for some discretionaries. Japan's Topix has trailed its peers of late, lagging UK, US, European, emerging market and global indices year to date. As with emerging markets, allocators could be taking a firmer view on which exposures are working better than others this year. For now, Japan has replaced Europe as wealth managers' least-loved equity region of 2019.

Structural threats

A not unfamiliar refrain in recent years: which is right, the stock market or the bond market? Those mutterings have increased again this year as sovereign debt rallies in tandem with equities. 

Convention has it that this parallel should be seen as a warning sign for shares. And the cliché that the bond market is smarter than stocks leads many to believe the bear case: the economic outlook is gloomy, and getting darker all the time.

The analysts behind JPMorgan’s Flows and Liquidity note have a different take. They suggest the growing might of the “fixed-weight allocation investor” - from pension funds, to balanced funds, to risk-parity strategies in the US - has altered the dynamic. The need for rebalancing means a bond rally leads to overweight bond positions having to be offset by additional equity exposure. 

The conclusion, according to the analysts, is that “the intensification of this year’s bond rally in May and June has put even more pressure on such investors to rebalance away from bonds or deploy available funds into equities”.

What’s more, while many equity indices are hitting the highs reached last year, JPM thinks there's still a bit more room to go - again, because balanced investors are currently underweight equities, whereas they were overweight going into last October.

All relatively reassuring, and an argument that will strike discretionaries as logical enough given their own tendency for regular rebalancing. 

But the downside to the theory is what happens if and when bond yields go into reverse. It implies equities will do so in tandem, creating the kind of diversification dilemma that's cropped up on more than one occasion in recent years. That may be a way off given current monetary policy trends, but wealth managers will be keeping it in mind nonetheless.

Little wins

Three years on since the Brexit vote, and the big winners of the fund world aren't hard to guess. US equity and tech-focused strategies come out on top, as they do over most other time periods an investor could care to think of. 

UK fund buyers may be more interested in exactly how their domestic exposures performed over this period - but again, the story here has long since been baked in. 

Despite the slump suffered in the months after the referendum, small-cap funds have outperformed their larger equivalents over the three-year period. But this is a trend that reasserted itself as far back as early 2017. Old news as far as fund selectors are concerned.

All that said, small-cap strategies have proven their resilience on more than one occasion since then. The fourth quarter of last year is a case in point. Yes, the average fund fell 16 per cent - but this wasn't much more than the 12.5 per cent drop sustained by all-cap portfolios. And this May, when the large-cap rally seen in 2019 withered away, small caps were more or less flat. Among all the gloom, there's a lot to be said for the hardy UK businesses at the lower end of the scale.