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Cash mismatches threaten DFMs' cautious stance; Hedging help arrives for allocators

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Caution to the wind?

With half of 2019 done and dusted, investors can be relatively content with the way the market rebound has endured this year. That rally has meant major global indices - Japan excepted - are now in the black again on a 12-month view. 

Think back to this time last year, and a gradual grind higher for equities was arguably the consensus forecast. In that regard, it’s mission accomplished. This year, nerves are a little more strained: global growth is stuttering, and eyes have turned to this weekend’s G20 summit in the hope of some kind of trade-war breakthrough. 

Most wealth managers would say they’re cautious, too. But the data hints at a slightly different outlook. An analysis of DFM cash allocations then and now presents a rather mixed picture. 

Cash allocations have crept up, on average, over the past 12 months, but that’s far from the whole story: on a case-by-case basis, only one in two wealth managers is running more cash in a typical Balanced model than they were a year ago. Some have stuck with existing allocations, and a third have instead cut weightings over that period.

Natural variation isn’t necessarily the only explanation here. Some would have seen Q4’s big dip as the best opportunity in a long while to put some cash to work.

That said, the start of 2018 was also characterised by a small sell-off. So cash weightings may have been relatively low at the start of our sample period - and yet they’ve subsequently fallen further. 

An alternative theory is that discretionaries have been happier to put money in bonds, or alternatives, as diversification tools. But there are reasons to be sceptical here, too: bonds and equities have been rising in tandem for some time now, and the end of last year showed how alternatives can disappoint

Next month we’ll be taking a closer look at how wealth managers’ allocations have changed over the past year, but as it stands, those who have been eating into their cash piles may find themselves exposed if the second half of the year turns nasty.

Buried treasure

The sovereign debt rally of 2019 has caught out many allocators - to the extent that those who missed it may now be wondering if expectations of looser monetary policy and shakier economic growth are all-but priced in. Ten-year Treasury yields are now sitting around the 2 per cent mark, having been above 3 per cent as recently as December. But there's more than one reason to think US government debt looks attractive at the moment.

For one thing, the difference between US yields and those elsewhere remains significant. And barriers to entry that have hitherto hindered wealth managers' ability to invest could be about to fall.

Interest rate differentials have resulted in punitive hedging costs for investors hedging Treasuries back into sterling, meaning wealth managers have been forced to take a step back from this approach.

That's particularly the case at the moment: as TwentyFour Asset Management notes, the price of currency hedging can “typically spike” at the end of Q2. Yesterday this translated into a 334 basis point cost for an investor wanting to hedge Treasuries back to euros. Hedging to sterling is also far from cheap.

But TwentyFour chief executive Mark Holman sees better news on the horizon. The half-year spike should fade out next week, reducing the current gap by around 35 basis points. And US monetary policy could help, with the US yield curve pricing in 75 basis points of cuts by the end of 2019.

When it comes to hedging, at least, the suggestion is that Fed rate cuts haven't yet been priced in. Mr Holman says:

For investors who currency hedge that would mean dollar assets, which have been so expensive to hedge back to euros or sterling, would become more attractive. Investors need to consider the future price of currency hedging, not just the current price, which looks to be at its peak.

Disappointing data

A warning shot, of sorts, has been fired at DFMs by a research paper analysing the impact of Mifid II implementation across the sector. Discretionaries are still finding it difficult to marshall the information required to produce the necessary costs and charges disclosures - particularly on an ex-post basis - and it looks like there’s limited tolerance for this state of affairs.

The research, by AKG, saw almost a quarter of surveyed advisers say the standard of reporting and transparency on charges and services “always influences” their choice of preferred DFM, with a further 39 per cent saying it was a consideration. And at the moment, teething problems are very much in evidence: almost half say the quality and clarity of charging reports are “disappointing”.

DFMs might not unreasonably state that the quality of their own data is dependent on product providers, and that further guidance from the regulator would also be welcome. But however justified those excuses may be, the clock appears to be ticking nonetheless.

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