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Asset Allocator

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Selectors shun alternative income plays; The worm turns for riskier fund picks

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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High hopes

The demand for income portfolios is so great that, much of the time, offering just one simply isn’t enough. Around three quarters of wealth firms provide an income model to clients, with several running either a range of yield-focused portfolios or an additional 'high income' strategy.

The question that then arises relates to how DFMs are producing this extra yield. To answer that, we’ve analysed those firms offering both income and high income strategies, and contrasted the allocation decisions within each. The results are below:

The most obvious difference, as we've noted before with other income portfolios, is that high income offerings boost their yield via greater exposure to domestic shares. That makes sense at the moment, given the UK market still yields more than 4 per cent.

And it's equities in general, rather than other income sources, on which DFMs tend to rely. We've highlighted another big riser in the chart - Europe - but EM, Asia and Japan positions also rise by about a third. The exceptions are global equity weightings, which have come down slightly, and US weightings which are roughly flat.

The flip side of this is that fixed income allocations drop back. And alternatives fall away, too. Allocations to the likes of absolute return funds dropped notably in our sample, which makes sense given many offer no yield. More surprising is that exposure to the likes of property is also reduced. That suggests discretionaries, faced with the need to produce higher incomes while still managing risk, are tending to trust in equities more than alternative income plays.

Dividing lines

Tech has been back on a tear in the US, but the dominant theme of the past decade hasn’t picked up where it left off everywhere else. In emerging markets the story is a little different: macro concerns over China mean the big internet names are still under pressure. 

Investors’ shift to a more defensive mindset - which comes despite EM being a consensus bet at the start of the year - may be an opportunity for wealth managers, according to recent analysis by broker Stifel.

Simply put, tech stocks are no longer driving benchmarks higher in Asia. That makes it easier for emerging market fund managers, who are naturally focused on more than one sector, to outperform.

Stifel confines its analysis to EM investment trusts, all of which are level with or ahead of the MSCI Emerging Markets index over the past year. The same trend can be observed among open-ended funds: having lagged the benchmark in recent times, the average strategy has outperformed a flat market over the past 12 months.

That might come as some solace to DFMs who have hitherto been frustrated with either their own fund choices in the sector, or the way in which emerging markets have flattered to deceive on the whole this year. But this shift in dynamics isn’t just about a single sector: it also means that dividend strategies are starting to outperform, too. Tech may now be a dividing line between the US and EM markets, but those looking for income look set fair in either region

New rules

In the current climate, it was perhaps inevitable that the continued fallout from the gating of Woodford Equity Income would descend, in part, into a discussion of UK versus European regulatory approaches. So it was that the European Commission yesterday hit back at suggestions Ucits rules were to blame for the suspension. 

The FCA, in short, thinks some issues boil down to a failure of the rules. The Commission argues it was a failure of supervision. 

The former’s scepticism of an “excessively rules based system”, as Andrew Bailey described the Ucits framework to Parliament on Tuesday, is of a piece with its overall mindset. Whatever the cliches, the FCA does tend to avoid being too proscriptive where possible: a disinclination to provide templates for Mifid II cost disclosures is one pertinent recent example. But there are times when a firm hand is required, and - with the benefit of hindsight - the Woodford case looks like one of those occasions.

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